Jubak's Journal
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Reader CEOs fix Merck, Delta and Schwab
Readers put on their CEO hats and propose smart strategies for turning around these troubled companies. Now if the companies would only listen.
By Jim Jubak
In my Dec. 17 column, I challenged you to put on your CEO hat and fix one of three deeply troubled companies, Delta Air Lines (DAL, news, msgs), Charles Schwab (SCH, news, msgs) or Merck (MRK, news, msgs). Congratulations, you rose to the challenge.
In more than 400 e-mails, you proved that you are ruthless, cynical and smart enough to turn these companies around.
I cant possibly do full justice to all the plans I received in one column, but let me give you the flavor of the suggestions and longer excerpts from what I think were the best plans. Ill be e-mailing the winners individually in the next few days to ask which of the three investment books I offered as prizes -- "The Stock Trader's Almanac for 2005," "The Coming Generational Storm" (Laurence Kotlikoff and Scott Burns' very scary book about war between the generations over retirement), or Aswath Damodaran's new book "Investment Fables" -- they would like.
Merck brings out readers tougher side
No company brought out quite as many ruthless suggestions as Merck.
Reader K. Lee wrote: I'd take whatever money in cash the corporation has, form a new corporation, have some of those overpaid executives run the new corporation, sell the assets of the nonproblematic drugs into the new corporation, offer to license some of the new drugs to generics, saturate the market with the new products and drive out the competitive products. Dump the assets of Vioxx into a sacrificial shell of Merck and then let that shell go bankrupt.
One reader, J. OSullivan, had a detailed plan for dressing Merck up for a possible sale: To address the potential $15 billion in legal liability from the drug Vioxx, use $8 billion of Mercks cash to set up a dedicated reserve fund. That money would be invested in a portfolio of corporate and government bonds with maturities laddered to match projected legal costs. Another $1 billion a year from cash flow would be dedicated to the reserve fund. That would assure any potential acquirer and investors that the company would survive the Vioxx settlements.
Readers seemed equally divided about whether Merck should acquire another drug company or two to fill its pipeline or sell itself off to Pfizer (PFE, news, msgs) or Johnson & Johnson (JNJ, news, msgs). Suggestions for acquisitions included big drug companies Eli Lilly (LLY, news, msgs) from reader Neeraj Gupta, Abbott Laboratories (ABT, news, msgs) from reader Robert Clodfelter and Baxter International (BAX, news, msgs) from reader Scott Bender. Reader Keith Morgan suggested biotechs such as Orchid Biosciences (ORCH, news, msgs) and Pharmos (PARS, news, msgs).
Winning suggestions
Mercks problems, the prospective CEOs recognized, wouldnt be fixed by simply filling the product pipeline. The Vioxx debacle has left the company with a badly damaged brand that needs to be repaired. Suggestions ranged from more PR (reader Eddie Gilpin) to outside, independent product-review boards to top-to-bottom overhauls of the companys culture (reader Cirk Bejnar).
One entry that I found impressive -- from the co-winner of the Merck CEO prize -- combined all these elements.
From reader Loren Lieberthal:
Long-term: Use some of that enormous cash reserve to buy an emerging high-tech biotech firm.
Public face: Set up some very public internal review boards -- a huge step toward restoring public confidence. Release weekly White Papers on progress.
5-step economics: 1) Trim internal hierarchies (believe me; they have more layers than the onion you'll have for lunch); 2) Co-market an established or emerging drug with another Big Pharma (or small one that needs it); 3) Buy Bristol-Myers Squibb (BMY, news, msgs); 4) Push for Propecia to go OTC, reap the cash benefit from balding baby boomers and 5) Create an altered-molecule version of Zocor that stays on patent (similarly, Nexium is an altered molecule away from the OTC version of PriLosec).
Related commentary on MSN Money
The other co-winner didnt offer as concise a prescription for fixing the problem. But this reader would clearly be a CEO with the vision to shake up Merck.
From reader Dave Livingston:
The fundamental problem for all the large pharmaceutical research companies is that their research models are tired and rapidly dwindling in productivity. Now they're in a point on the curve where the yields are declining and incremental improvements in known areas are not worth the price increases, let alone the huge new R&D investments. The economics are further worsened because all the big pharmas have grown themselves to the size where $500M blockbusters no longer make enough money, but they need $1B+ ones.
This problem has been building for over 10 years. And from the front pages of The Wall Street Journal, we know it's been being ignored for almost as long -- especially at Merck -- but the real solution lies in finding a new research model and development processes.
Sadness for Schwab
The predominant mood of the prospective CEOs offering plans for a turnaround at Charles Schwab was sadness. Many were former or current customers who felt that the company had drifted away from its roots.
Get back to what the firm does best, wrote reader Tony Cash. I would love to be involved in turning around Schwab. It was a great discount brand and lost its focus by going upscale, said reader Matt Bradbury. Whoever takes over this company needs to bring the company back to its roots, wrote Sascha.
There was extraordinary agreement on the need to continue to cut costs. Schwab should sell or perform an IPO on U.S. Trust, the high-net-worth advice business that Schwab purchased, wrote Bill Cross. Cut the brick and mortar by 20% each year for the next three to four years, suggested Reg Baker.
And what company should the new Schwab model itself on? Not a financial peer, but Costco Wholesale (COST, news, msgs). Think Costco of the financial world, wrote Bob Fenton. Terrific selection, very good prices (and sometime the best prices), good service, clean (think resolute governance) with enough of a personal touch that you can always find what you want to buy. And reader Joseph Burke suggested, Schwab has to take a page from Costco and become customer friendly.
The two winning Schwab CEO plans combine all those elements:
I would 'reinvent' the company, wrote reader Bill Mathis: The new company would be totally user-friendly. It would offer life-cycle banking, investment, and financial products and services, beginning from newbies, i.e. kids just learning to manage financial affairs, through the seniors who want their money to outlive them! The company would offer learning and training services, in effect growing their own future mega-clients.
Schwab needs to change the playing field from price to value, suggested reader Jim Emerson. It is my understanding that most do-it-yourself investors do not make money. They may save on fees, but their accounts do not grow. Schwab is in a position to be the leader in education for the do-it-yourself investor so that they can make money. Much like McDonalds (MCD, news, msgs) did with Hamburger University to teach its franchisees how to make money selling hamburgers, Schwab should start Do-It-Yourself Investor University. Within a year or so, this strategy would allow the company to run ads featuring testimonials from their university graduates on how their accounts grew versus how low their fees were. The basic message would be, You may be getting $7 trades, but with the help of Schwab my account grew. I am now a successful investor. Rather than losing investors to T.D. Waterhouse and Scottrade, many would be coming back because the playing field had changed from price to value."
Plenty of suggestions for Delta
I guess Jubaks Journal readers like a challenge. Delta, the company closest to bankruptcy, drew the most readers eager to be CEO by an almost two-to-one margin.
There wasnt any consensus in the group. It split almost right down the middle between CEOs who believed that air travel was now a commodity product where cost-cutting was the only game to play, and CEOs who believed Delta could find a way to escape the spiral of ever-lower prices that the airline industry seems to face.
The only real solution for competing in a commodity price market, Tim Crowell wrote, is providing a commodity-type service. Reader Steve Marcin felt that the current cost-cutting was a good first step, but he would extend the cuts by eliminating low-volume airports and cutting the size of Deltas fleet of aircraft. Tushar Patel would cut the least-profitable routes and outsource any jobs that can be outsourced. William Lynn Robinson would suspend all bonuses and raises for management, and he would base ticket prices on the weight of the passenger because it takes more fuel to fly a heavy passenger than a light one. Daniel Weis suggested cutting costs by adopting the computer-only ticketing models of the low-cost carriers
Other readers sought to find ways to escape the commodity box. Delta must offer something more -- at least something that is perceived as more, wrote reader Pietro DAleo. Focus on a monthly or annual subscription-based model, wrote Barry Gainsburg, so that business travelers could accurately predict their costs. Cater to the business traveler, but at less-than-business-class prices, by providing wider seats (to accommodate a laptop) and noise-canceling headsets for a modest premium, suggested Chris Preisig. On a somewhat grander scale, reader S. Shanks suggested, Expand vertically. Buy up some islands, maybe with a casino and some penguins, and fly there, offering terrific deals.
The two co-winners of the Delta CEO prize take the idea of creating value much, much further.
Shamelessly steal from Burger King, wrote reader Charles Mustapich. Develop fly-your-way seating with incremental prices to allow passengers to avoid annoyances. For example, sacrifice one row of seats to set up an adult-only quiet zone at a premium price. Or, how about a low-cost frills package for coach customers that expands on the current onboard a la carte offerings of headsets and beverages for a single price.
Reader Aaron Ricker goes even further. I propose that Delta take its fleet of 757-200s and 737-300s and turn them into all first-class seating aircraft while still charging fares that are in the same range as its coach-class competitors. If the aircraft can achieve a 90% load factor, they will exceed the revenue generated at current prices and current 75% load factor, and the break-even load factor of 83%. Ricker would apply his plan to international flights as well, but not to shorter domestic trips where the added comfort over a short duration isnt enough to support premium prices.
And finally, Im awarding an additional, special CEO prize to reader Tony Beal, who came up with a Christmas plan that fits any company in need of a turnaround. It has just three steps.- Top management watches Miracle on 34th Street and realizes that genuine care for their customers beats greed.
- Management agrees to tie compensation to profit. No profit, no bonus.
- A courageous, independent board fires the greedy scoundrels that are dragging the companies down.
Only in the movies? Tis the season of hope.
New developments on past columns
Im insuring my portfolio with land
Time to raise my target price on The St. Joe Company (JOE, news, msgs). On Dec.16, the company announced that it had sold 93 acres of land in Panama City Beach, Fla., to Simon Property Group for $26.5 million, or about $286,000 an acre. (At the same time, the company raised its guidance for 2004 earnings to $1.04 from $1.00 a share. But remember, this stock really doesnt trade on earnings but on the value of the land behind each share.) Now, shares of St. Joe are up 83% since I added them to Jubaks Picks on Oct. 3, 2003. At that point, the market was valuing the 900,000 acres of Florida real estate the company owned at about $2,700 an acre. Well, after that 83% jump in the stock, the stock market is giving that land a value of about $5,400 an acre. Of course, not all that land will be sold and not all of it is as valuable as the land that Simon Property Group just bought for $286,000 an acre, but I still think theres a huge gap between the market cap of this stock and the value of the real estate it owns. (Im now using the Dec. 31, 2003, figure of 850,000 acres for St. Joes holdings.) As of Dec. 28, Im upping my target price to $84 a share by December 2005. (Full disclosure: I own shares of St. Joe Company.)
Changes to Jubaks Picks
Sell Oshkosh Truck
A little late, but Oshkosh Truck (OSK, news, msgs) finally hit my $68 target price and I think its time to take some profits in these shares. (For Jubaks Picks, where I have a choice between all or nothing, that means Ill be selling my position. For you in the real world, Id suggest trimming positions rather than selling all your shares.) The stock is now up 27% since Oct. 12. Thats triggered a rash of insider selling (a tad early at $62 or so) and the stock now looks in need of a pullback in the new year. Im selling with a 16% gain since I added the stock to Jubaks Picks on Jan. 27, 2004, at $59.61. (Full disclosure: I will be selling my personal shares in Oshkosh Truck three days after this column is posted.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this columns: Oshkosh Truck and The St. Joe Company. He does not own short positions in any stock mentioned in this column.
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