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Bill George

Harvard Business School Professor, former Medtronic CEO

New York Times DealBook – When Activist Investors Aim at Strong Companies

From New York Times DealBook, November 20, 2014

Activist investors have the “hot hand” these days. Their calls to break up companies have attracted growing attention, and their hedge funds continue to add new capital. Bill Ackman, for example, netted more than $2 billion on his investment in Allergan. He pressured its board to sell to Valeant, but profited even though the company was ultimately sold to Actavis. Carl Icahn challenged Apple’s cash hoard, while Mr. Ackman dislodged Robert McDonald as chief executive of Procter & Gamble. Chief executives are concerned that their company may be next.

Fueled by growing funds under management and emboldened by media coverage, the activists have recently shifted their focus to targeting America’s best companies. Why are activists pursuing those companies instead of moribund companies on the wrong track? The lofty strategic rhetoric of the investors notwithstanding, they are looking for quick gains. This may net handsome profits in the short-term, but it places the competitiveness of America’s great global companies at risk.

Let’s examine four situations among some of America’s best companies — Amgen, PepsiCo, DuPont, and Allergan — to see where activists have it wrong.

Amgen Under the leadership of Kevin Sharer and Bob Bradway, Amgen has been a stellar performer. In the past five years, its stock has increased 185 percent. Apparently dissatisfied with this performance, Mr. Loeb wants to break up the company. Break it up? It’s all one business. Centralized research and development fuels innovation that results in a steady array of breakthrough drugs. Amgen has exceptionally high net income margins of 27 percent and generates $6 billion a year in free cash flow, even after investing 22 percent of its revenues in research. Mr. Loeb’s idea of splitting older drugs from newer drugs would destroy one of America’s most productive innovators by taking away the cash it needs to develop new drugs, meet patient needs and fuel the company’s growth.

PepsiCo When she became chief executive in 2006, Indra Nooyi foresaw the need for healthy foods and beverages — trends currently sweeping the globe — and devised a long-term strategy to broaden PepsiCo’s portfolio. Pepsi’s performance the past three years has been exceptional. Its 52 percent stock price increase is double that of its archrival, Coca-Cola, which is trapped in a single-minded strategy focused on carbonated soft drinks and bottled water. Nevertheless, the activist investor Nelson Peltz is agitating to split PepsiCo in two, just as he did with Kraft. But both Kraft and its spin-out, Mondelez, are struggling.

DuPont Perhaps stung by his inability to influence PepsiCo, now Mr. Peltz is trying to break DuPont into three pieces. Has he not studied what the chief executive, Ellen Kullman, has been doing the past five years? When she took over in 2009, 200-year-old DuPont was a disjointed conglomerate without a clear strategy. Its stock had declined 62 percent since 2000. Ms. Kullman immediately went to work to reshape DuPont’s portfolio for the future, spinning off slow growth, low-margin businesses like performance chemicals and coatings. Now, DuPont is focused on three high-growth, high-margin businesses: agriculture and nutrition, biotechnology and advanced materials. Ms. Kullman is using DuPont’s vaunted central research labs to drive innovation in all three sectors. Her strategy is working. The company’s stock has increased 250 percent since she took the reins.

Allergan Bill Ackman successfully partnered with Valeant’s chief executive, Mike Pearson, to put Allergan in play and ultimately force its sale to Actavis, but why was that warranted in the first place? Since David Pyott joined Allergan in 1998 as chief executive, he created a more than 2,400 percent increase in Allergan’s stock. Allergan spends 17 percent of its revenues on research and development. These smart research investments have sustained the company’s high growth rate. Valeant’s strategy was to cut Allergan’s research spending to 3 percent of revenues, lower its taxes from 34 percent to 3 percent, and eliminate its executive team — which would ultimately make the company noncompetitive. For what purpose?

In contrast, an outside perspective can be a powerful catalyst for improvement at performing companies that are not performing well. Ralph Whitworth of Relational Investors helped save Home Depot by unseating its chief executive, Bob Nardelli, in favor of Frank Blake, leading to a decade of strong performance. Mr. Whitforth also turned around a dysfunctional board at Hewlett Packard, one that had previously fired three successive chief executives. Likewise, Jeff Ubben of the hedge fund Value Act Capital Management pressured the Microsoft board for change after 14 years of marginal leadership by Steve Ballmer. Since Satya Nadella took over last February, the tech giant’s stock has jumped 75 percent.

But in the case of strong companies with effective managements, activist attacks are enormously distracting. Executives focus on saving their companies and short-term financial moves, instead of winning global competitive battles, creating great products and building new businesses.

Trying to break up great companies only weakens one of America’s greatest competitive advantages: the leadership, strength, and adaptability of its global companies. The activists should keep their focus on the underperformers, and work to build the next set of great companies like Amgen, PepsiCo, DuPont and Allergan.