2 Companies that Know how to Adapt
Demitri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
IBM (NYSE: IBM) used to have a thriving hardware business that was the envy of the tech industry. But no more. Berkshire Hathaway (NYSE: BRK-B) had a once profitable textile business, from which the conglomerate gets its unusual name. It’s gone. And at one point Apple (NASDAQ: AAPL) had a pretty nifty music player business with revenue that could have powered a Fortune 200 company on its own. Now not so much.
Each of these companies did something dramatic with their promising businesses: they walked away. Big blue abandoned computers for IT services and consulting, with revenue eclipsing that of hardware sales by 2001. Berkshire shut down the textile operations in 1985 to direct capital toward more productive uses. And Apple’s iPhone-induced cannibalization of the iPod really took hold in 2009. These particular business adaptations worked out for the best. Since their old-yeller moments, Apple, IBM, and Berkshire stocks have handily outperformed the market.
It is rare to find a firm that -- on its own terms – can take its commoditized businesses behind the woodshed in order to open up better opportunities ahead. Much more common is the scenario where the company is forced, kicking and screaming, toward that commodity dead zone, as Dell and Nokia are witnessing now.
But as these examples make clear, it’s absolutely worth hunting for businesses that can fundamentally adapt to changing market conditions. A company that's able to direct itself up the value chain like that demonstrates long-term management focus and a nimble organization, essential ingredients if you are looking for companies with the potential to compound earnings for the years and even decades ahead. Expanding margins are just the most obvious pay off from adapting up the corporate value chain.
Come on, chameleon
There are two promising companies that I see taking that gamble now, and the first is design software firm Autodesk (NASDAQ: ADSK). As it transitions its software suites into the cloud and to mobile devices, Autodesk hopes to become a has-been in the PC-based engineering and design business. The company just completed an aggressive reorganizing of its business with the goal of leading its industry in transitioning to the cloud. At the same time, the company has been pushing into mobile apps in hopes of broadening its reach and extending its software's relevance. A great example of both these strategies at work is the company's new app, called 123D Catch, which allows iPad owners to use the cloud to render 3D images of objects using a progression of pictures they take themselves.
Autodesk has been successful so far in its transition. Despite slowing revenue growth, operating margins ticked up last quarter, to 16%. And gross margins came in at an industry-trouncing 90%. But heavy exposure to the infrastructure industry, and to Europe, has kept the company's share price underperforming the market so far this year.
Another firm playing the chameleon game well right now is toy producer Hasbro (NASDAQ: HAS). The maker of My Little Pony and Transformers decided a few years ago that it wanted to internalize control over how its properties were being showcased in the entertainment world. So it invested in something that it had no business investing in: the studio and TV business. As a result, the company now develops and produces shows based on its deep catalog of brands. And through its joint venture with Discovery Communications, Hasbro airs these 30-minute brand showcases on its own television network.
Results at this early stage are encouraging, as the entertainment division's contribution to Hasbro's profit went from negligible to over 10% last quarter while product revenue fell slightly. And there is every reason to believe that as the network ramps up in ratings it will drive interest in the company's brands, with significant merchandising benefits to come. Who says a toy company can't play Hollywood?
You come and go
Businesses that refuse to risk their own cash cows for a long-term strategy eventually run into competitors that are willing to do it for them, often with deadly results. On the other hand, find a company that has the vision to identify the change that's needed and the ability to implement it and you have the potential for a winning investment. That's something that won't change.
SigmaSwan owns shares of Apple, Berkshire Hathaway, and Hasbro. The Motley Fool owns shares of Apple, Autodesk, Berkshire Hathaway, Hasbro, and International Business Machines. Motley Fool newsletter services recommend Apple, Berkshire Hathaway, and Hasbro. 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.
