Procter & Gamble is Still Better off with the Devil it Knows
James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With just a quick glance at last quarter’s earnings, it might look like Procter & Gamble (NYSE: PG) is doing well enough to leave alone… why fix what isn’t broken? The consumer staples icon earned $0.82 per share versus consensus expectations of $0.77.
If you take a closer look the picture starts to look a little less encouraging. While the company topped estimates, it only matched the year-ago numbers. Revenue – perhaps the bigger litmus test – fell 1% (though it would have been up a bit had it not been for currency fluctuation). Procter & Gamble’s outlook for the current fiscal year, which began this quarter, was less than riveting -- per-share profits are forecasted to be right around $3.88, compared to $3.89 for the prior 12 months. If the expectation is on target, 2013 will mark the fourth straight year of falling per-share profits.
Those problematic numbers, however, are the least of CEO Bob McDonald’s worries now. His bigger headache is Pershing Square’s Bill Ackman who, after last quarter’s lethargic results, may finally have a strong enough case to start making big changes at P&G.
Given three years of non-growth from Procter & Gamble, those changes are something many shareholders are apt to clamor for now. As much as something needs to change, however, investors may want to rethink whether or not they want Ackman to lead those changes.
Does the name ring a bell but you don’t know why? Bill Ackman is the guy who, through his hedge fund Pershing Square, largely took over J.C. Penney (NYSE: JCP) in October of 2010. Though most assumed it was another play on the company’s real estate assets, he says he saw an opportunity to turn the struggling retailer around (more here), and began enacting changes to that effect. Part of those changes have included overhauling the pricing and promotional efforts, keeping stores closed at normally weak sales hours, and ramping up the 'store within a store' feel … pretty big changes by retail standards.
Regardless of the actual motivation, it hasn’t mattered regarding the company’s performance. J.C. Penney between 2010 and 2011 watched its top line shrink from $17.75 billion to $17.26 billion (-2.7%). It also watched its bottom line shrink from $378 million to last year’s $152 million loss. It doesn’t look like things are going to start getting any better anytime soon, judging from last quarter and the company’s earnings outlook.
While certainly frustrating for shareholders, and likely for Ackman, it may not be the misstep he made with J.C. Penney that should have Procter & Gamble owners worried now. To really appreciate why P&G may be better off without Ackman’s “activist” brand of involvement, you really have to go back to his 2007/2009 debacle with Target (NYSE: TGT).
Here’s the abridged version of the story: In 2007, Bill Ackman shelled out $2 billion for a stake in Target stores through a single-stock fund established exclusively for this venture. The ultimate goal, not unlike the Penney’s purchase, was to unlock the value of Target’s company-owned real estate as well as bring the retailer back to its glory days. The plan? For Target to sell a portion of its real estate to a REIT that it would at least partially own, effectively renting property from itself for 75 years, yet putting some cash in the coffers (more here).
The spin wasn’t a tough sell to many investors. It's possible investors didn’t think the proposal all the way through, however … perhaps why Ackman may be motivated to persuade the company to rent what it already owns. Though ‘more cash’ is always good, so too is ‘no rent payment.’ Either way, if you rent something long enough, the cost of that ongoing lease will eventually exceed the value of the property in question.
Or maybe this will better make the point: Would you sell your house to your neighbor, cash the check, and then rent the house from him/her for longer than the traditional 30-year mortgage? Most would answer no.
Besides, it’s not like Target was cash-poor around 2008 – it ended the year with $562 million in the bank, and it wasn’t exactly experiencing cash flow problems at the time.
It has an aroma of an ulterior motive, and the deal itself opened the door to potential moral hazards. Namely, how to (or who gets to) determine the value of the real estate Target would be selling to a REIT that it didn’t actually control? Said more bluntly, it’s hard to believe Bill Ackman was engineering the idea just ‘cause he’s a nice guy. Regardless, after it became clear the deal wouldn’t get done, the $2 billion fund Pershing Square collected to make the Target/REIT deal happen ended up losing 90% of its value for those who chipped in.
It’s not the only reason, however, current P&G shareholders might want to think long and hard about how much involvement they want from Ackman.
Shortly after the deal fell apart and Ackman started to receive the understandable criticism, he penned a lengthy response letter to a column written by NY Times columnist Joe Nocera. Here’s the whole letter, but there’s one snippet from Ackman’s response worth noting regarding Target’s board at the time:
“None of the directors [of the board] have CEO-level, retail, credit card, or real estate expertise — the company’s principal business lines and major assets.”
Fair enough; it’s a point worth bringing up. On the other hand, it’s more than a little inconsistent with his decision to place Ron Johnson as the CEO of J.C. Penney.
Johnson, prior to Penney, had spent 11 years with Apple. Granted, he got Apple’s retail stores up and running, but comparing Apple’s stores to J.C. Penney is like comparing a Ferrari to a Pinto.
To be fair, prior to joining Apple, Ron Johnson served as the Vice President of Merchandising for Target. It’s technically relevant experience in that it’s “retail,” but as those who are in retailing will know (just for the record I spent several years in department store retail management), merchandising -- even in a VP role -- isn’t anywhere close to being CEO-level experience.
Ackman was worried about a lack of related CEO-level experience from Target’s board of directors but wasn’t worried about a lack of related CEO-level experience from an individual he hand-picked to actually be a CEO! It’s inconsistent at best, and at worst has to leave Procter & Gamble shareholders wondering if any personnel changes he initiates at P&G could be equally ill-advised.
Bottom line? It’s not like Ackman hasn’t had good luck or hasn’t produced big results from some of his deals. Enough of his deals have completely bombed, however, to prompt some worry from P&G’s owners now. Sometimes the devil you know is better than the one you don’t.
jbrumley has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend The Procter & Gamble Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.