By Genia Turanova
Once again, an old-school company fails to keep up. Or just fails.
General Electric (GE), which just a month or so ago seemed to be out of the woods after two years of declining earnings and dividend cuts, just warned investors of another year of lower profits and forecasted that its industrial operations — formerly its bread and butter — could be up to $2 billion cash-flow negative this year.
Just a month ago, the market was cheering GE’s decision to sell one of its important assets, the company’s biopharma unit, to Danaher (DHR) for $21.4 billion. The deal is expected to close in the fourth quarter. But the proceeds won’t be reinvested in the business. Rather, the proceeds will be used to reduce GE’s enormous debt. At year-end, GE had $108 billion in debt (almost as much as it had taken in revenue during the entire year, which was $121.6 billion).
The decision to reduce debt is the right one. The size of a company’s debt matters, especially when business suddenly slows. Too much debt can often lead to bankruptcy — even in a strong economy like ours today, let alone in leaner times. But when investors in supposedly “safe” stocks like GE are subjected to these kinds of rattling moves, it begs some serious questions about how we as investors should be approaching our decisions.
Take for example Windstream, a rural telecom whose business had called for leveraging, filed for Chapter 11 bankruptcy protection February 25. Windstream had more than $5.8 billion in debt and loans and its bankruptcy filing was, in fact, triggered by a violation of a bond covenant. I don’t need to tell you what such an event does to stock investors who are among the last to have any claims for a company’s assets. Windstream’s share price plunged from a 52-week high of $8.95 a year ago to just pennies today.
And since we’re on the subject, a company’s ability (or inability) to grow also matters a great deal to investors, even income investors. To put it simply, revenue and profit growth means that the company in question has a future. It’s also an indication of business health. Investors want to be sure they’re not buying into a deteriorating or stagnating situation. They’ll often review “growth” metrics first, even if they’re investing for income.
Similarly, businesses want to be sure they’re in a good situation for many years to come; if they’re facing stagnating or deteriorating sales, one quick fix is to buy a revenue and profit stream in the form of another company.
Grow Or Die
For a pharma company facing a reduction in sales because a product is going off-patent, this decision is even easier. That’s what’s been happening in the large pharmaceutical and the biotech industries for a while now.
As I mentioned earlier today, it is well known that the patent cliff — the projected sharp revenue decline when a major drug’s patent is set to expire — has cost large pharma companies many billions in revenues. In 2011, for instance, patents on drugs with annual sales totaling $12 billion expired. In November of that year alone, four major drugs totaling more than $7 billion in sales — including best-selling Lipitor — lost patent protection.
It’s no coincidence that M&A activity heated up in the year or two immediately preceding the 2011 patent cliff. In 2009 alone, Pfizer bought Wyeth Pharmaceuticals for $68 billion, the seventh-largest pharma deal ever, and Merck bought Schering-Plough for $41.1 billion.
Large pharma is still in danger of losing large chunks of revenue as patent protection — even for biologics, a newer type of drug made from live organisms or components of live organisms. (In this article, I reviewed the top medicines about to expire and the companies that own those drugs. The revenue lost from these drugs will make for a big hurt going forward or drive them to buy a competitor — or both. I highly recommend you read that piece to fully understand the point that growth is all-important in the world of business and investing.)