We recently spent two days taking in management interviews and presentations at an Industrials investment conference in New York. With a few exceptions, the message was the same: “Business is tough, we’re de-leveraging, and M&A remains an important part of our long-term growth strategy.” Few could dispute that the operating environment remains tough, but management teams spent little time talking about driving long-term growth through innovation.
Overall, the companies we saw had disappointing first quarter performance, with soft activity in North America compounded by issues in China and Brazil, weak business in the oil sector and unfavorable foreign exchange from a year ago. Meantime, the stocks of many of these companies are up sharply since the beginning of the year. Rebounding oil prices and a weaker USD have helped propel some of these companies’ stocks up more than 100%, even though many management teams expressed no expectation of a business pick-up. All of this is still more surprising, as global equity funds have seen redemptions of close to $90 billion this year to date.
Looking and listening to the presentations, we were struck by the consistency of the messages focusing on the steps these companies are taking to reduce costs to improve financial performance. The drive to extract cost synergies from recent acquisitions, fueled by cheap funding, was mentioned by just about every company, many of which completed large transactions over the prior 12-to-24 months. The focus on financial engineering, including stock buybacks, overshadowed talk on innovation.
To be sure, some management teams noted what they are doing to sell more to current customers. Others briefly highlighted some growth areas of their business, notably solutions for security and data management. But over two days, we didn’t hear one deep discussion on product development.
A great deal of commentary has taken place in 2016 across both investor and political spheres on the dangers of short-termism in global investment culture, its impacts and a need for greater capitalist responsibility. The long-termers see a crucial need to rebuild U.S. infrastructure, manage technological disruption and maintain and enhance the U.S.’s competitive positioning on the global stage while creating socio-economic opportunity and investor value. Clearly the ability to develop and monetize collective innovation is at the center of the ability to address these challenges. In an environment where investor scrutiny is amplified by increased volatility and poor performance across the mutual and hedge fund spaces, management teams too often fall into the trap of perpetuating the short-termer quarter-to-quarter strategy of appeasement.
Sure, times may be tough, and it is important to tell investors the actions a company is taking to reduce costs, streamline operations and improve return on capital. At the same time, it’s difficult to get excited about a long-term investment thesis without an appreciation for those things in the pipeline that will differentiate a company from its competitors, the long-term trends that will support growth and the investment in innovation across products and solutions that will enable the company to benefit from them. How a company is responding to changes in regulation such as energy efficiency, or mega-trends such as food safety and climate change, should remain essential parts of a company’s investor presentation.
The success of investing to grow a business organically is the acid test of a company’s management team. Providing insight into the process helps to build a more enduring investment story that will resonate with a broader investor audience. A balance needs to be drawn between short-term performance and management’s action to maintain it and the long-term equity story for which they are seeking investor support to realize.