Update: IBM, Amazon, Salesforce.com : Three major companies with over-priced valuations and out-dated business management strategies
Not being a connoisseur of the behavior and psychology of stock-market investors, I find it difficult to remain silent while watching what looks like consensual hallucinations among investors and company valuations that resemble impending train wrecks. Thankfully, many of the train wrecks I anticipate fail to materialize, at least at the time I forecast that they will occur. I don’t know whether this says more about my poor comprehension of the myriad dynamics affecting stock prices, or the problematic workings of the markets themselves. Anyway, for reasons beyond my complete understanding enough investors continue to treat these IBM, Amazon, and Salesforce.com as cases for special consideration, even though others already see worrying indicators in each company’s business management strategy.
As we’ve seen many times in the past, when the valuations of bellwether companies fall sharply the tremors can cause a double-whammy on the entire stock market and potentially set the entire tech marketplace back, sometimes by as much as several years. In the case of these three companies, I can only guess that there is some kind of conspiracy of silence or widespread denial keeping investors, especially institutions, as committed to them as they still appear to be. But if and when things turn sour, one CEO may well lose their job, leaving the company to hunt for a savior, while the other two CEOs are unlikely to be unseated due to their dominant shareholdings and personalities, but will almost certainly forfeit their considerable haloes.
First, let me restate my conviction about the value of having real power – whether through the growth in your category or portfolio, the differentiation of your company, strong positions in markets, the uniqueness of your solutions, and/or ability to execution – as strong reasons for significant, higher-than-average valuations. Theoretically and in practice, powerful franchises generate exponentially larger company valuations as compared to those of their closest competitors – and rightly so, because as customers continue to vote with their wallets, shareholders feel like they can look forward to years of persistent revenues, growth, and/or profits. The three companies named above all have powerful franchises in their target businesses and markets. Powerful in different ways: IBM is the dominant (though currently less than luminous) global IT systems vendor, but today has negative growth and earnings that are being artificially inflated quarter after quarter, pleasing shareholders but no one else; Amazon is the dominant internet retailer and leading cloud infrastructure service provider, with moderating growth but no sign of profits – in fact, increasing losses – because its revenue growth lags its expense growth by anywhere between 10%-20%. As a result, investors are becoming restive and critical of the company’s strategy; and Salesforce.com is the dominant Saas CRM vendor and standard-bearer for Saas companies in general, with strong though slowing growth and, even more so than Amazon, an apparent disinterest in achieving profitability any time in the foreseeable future. You cannot but admire the vision, strategy, and professionalism (in certain areas) that have made these companies into major players in their respective categories.
But as much as you can trust that the most powerful companies benefit from spiraling investor confidence, everyone knows that good things tend to come to an end – particularly in tech markets where creative destruction is an almost daily occurrence. IBM needs to fear being disrupted by Amazon, Google, and Apple, and even by Oracle or HP; in similar vein, Amazon cannot sit on its laurels while Ali Baba, Wal-Mart, Microsoft, Google and others plot to disrupt their hold on consumer and business budgets for retail goods; and despite its dominance in Saas-based CRM Salesforce can surely feel the breath of Workday, Oracle, Microsoft, and others on its neck. Perhaps Ginni Rometty, Jeff Bezos, and Marc Benioff know something that I don’t, that allows them to believe that their existing strategies will continue to work with investors and financial analysts, as well as customers and partners. But there are limits. The problem with all stock markets is to know when the special bubble which protects powerful companies while most investors feel they can do no wrong decides to burst.
In strategic terms, Rometty needs to find one or more growth catalysts in IBM’s portfolio, a business or businesses that can show sufficient growth potential to reach a billion dollars plus within a few years. IBM’s current public bet on its Watson cognitive analytics offering is still high-risk because the technology is still raw enough that IBM still has to deliver a custom project to every customer. Yet today, IBM has positioned itself so firmly around Watson that Watson has practically become the company in many people’s minds – a very risky marketing strategy. Other more established, less nascent forms of analytics such as predictive or real-time offerings focused on data warehousing for structured, semi-structured, and/or unstructured data, provide growth potential that IBM is not yet exploiting with sufficiently clear strategies or focus despite the company having invested billions in twenty or so acquisitions in the past several years. Furthermore, the management team and board really have to understand that the company needs an alternative go-to “strategy” to the financial engineering addiction that Sam Palmisano first installed in the company as its de factor earnings-growth mechanism during the second half of his reign as CEO.
As for Amazon, Bezos’s ambitions and strategy need to find some boundaries. In Amazon’s e-commerce domain, Bezos must abandon his hubris and stop trying to bludgeon the company’s major suppliers into oblivion. Whatever the rights and wrongs of each side’s approach, the public wrangles with Hachette and now Disney are not making Amazon any friends; furthermore, I would argue that the company needs to review its 20-year Walmart-style hyper-commoditization strategy, possibly adding some measure of customer intimacy to its renowned operational excellence. A combination of humility with a more nuanced market strategy will, I believe, result in a more satisfying set of business results for all parties going forward. Amazon is still a major provider of physical goods, whose sale price can never reach zero without everyone associated with them going out of business. Even digital goods will always have a minimum price if the key members of the book and DVD/video value chains refuse to go completely insane. On the AWS cloud infrastructure front, the same applies. Google and Microsoft have both got much bigger war chests with which to fight the profitless prosperity price war that AWS is waging, and they are at last focusing their guns on AWS, aiming to take large slices of market share away from the current leader. If cloud infrastructure was a more mature category, it might be game over in favor of Amazon, but that is not the case. This game is still in the early adoption stages as far as mid-sized to large enterprises and public sector customers are concerned, and AWS has only won the early market stage.
As regards Salesforce.com, Benioff and his team still owe investors a much more candid and truthful narrative about how they aim to build a sustainable business during the next decade. It may be okay to not produce profits for a portion of the time when the company is experiencing hyper-growth, but as I’ve argued in a prior blog on this topic, when the law of large numbers takes over and growth slows – as it has been doing for a while now – there is no excuse for not providing a credible path to good old by-the-book profitability. Although the 25% or so current y/y growth is still keeping many investors engaged with the stock, many others have abandoned it.
In conclusion, one thing the markets do not need is for one or more of these companies to suffer dramatic falls from grace because they stubbornly refused to adapt their current strategies to changing realities. It will be far preferable for all investors (except I guess for the most predatory hedge funds) to see the CEOs and management teams of each of these key players show that they are playing the game with a straight bat.