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INDUSTRY TRENDS

Analysis of AT&T’s Break-Up Plan Versus IBM’s Imperial Plan

Ma Bell’s Broken Heart

AT&T’s Armstrong Does What IBM’s “Last Emperor” Didn’t Have Courage, Wisdom to Do-Break Up His Empire. To Survive!

PHOENIX, Oct. 26  Ma Bell has a broken heart for the second time in her 115-year history.  And the man who is in charge of it is trying to mend it.  By breaking it up.  To survive.

Text Box:

Of course, this is the recipe we recommended almost five years ago to another industrial era relic - the Big Blue.  And for much the same reasons.  But unlike AT&T’s Mike Armstrong, a former IBM executive, the Big Blue chairman and CEO, Lou Gerstner, IBM’s “Last Emperor” as he is likely to be remembered, chose to try to run his company (into the ground) in one piece.

What has been rumored for some time now, became a reality on Oct. 25, following an AT&T board meeting at which Armstrong’s proposed break-up plan was approved.  The company will split into four units, using the same rationale we deployed in January 1996.  When it comes to stockmarket valuations, the sum of the parts will be greater than the whole, the AT&T board figured.

By now, enough ink has been used in the world and national business media to describe the details of the AT&T break-up plan.  So we are not going to dwell on it very much (refer to the summary table on this page).  The main purpose of this Annex Bulletin is to analyze the parallels between the situations AT&T and IBM find themselves in their respective markets today.  And then draw some hopefully fairly obvious conclusions as to what IBM should also be doing, but isn’t.Text Box: AT&T Break-Up

1. AT&T Broadband
	Revenues (1999):	$5.77 billion
	Employees:		37,100
	Subscribers:		16.1 million
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2. AT&T Wireless
	Revenues (1999):	$7.62 billion
	Employees:		18,300
	Subscribers:		12.6 million
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3. AT&T Business Services
	Revenues (1999):	$25 billion
	Employees:		38,000
	Subscribers:		6 million
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4. AT&T Consumer Services
	Revenues (1999):	$21 billion
	Employees:		18,000
	Subscribers:		60 million
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Total Revenue (1999): $64.1 billion

We will start that by applying to IBM some of the statements the Wall Street Journal made about AT&T in its Oct. 26 front page report headlined, “AT&T, Once a Corporate Icon, Finally Yields to a Humbler Role.”

·        First, the headline might as well have read “IBM, Once a Corporate Icon, Finally Yields to a Humbler Role.”

WSJ: “After more than a century of binding America together with sound waves and wire, AT&T Corp., once the country's biggest, wealthiest and strongest company, is itself unraveling.”

·        Ditto re. the above lead paragraph.  Just swap IBM Corp. for AT&T Corp.

WSJ: “Just a few decades ago, AT&T seemed like a paragon of corporate success and endurance… The company's millions of "widow and orphan" stockholders enjoyed a generous and dependable dividend. If ever there was a company that seemed primed for the future, AT&T was it.  But AT&T grew fat and complacent in the 1970s and 1980s while the telecommunications market was getting lean and hungry.”

·        Ditto, again.  Just change “telecommunications market,” to “PC market.”  Except that in IBM’s case, its luck ran out about a decade after AT&T’s first heart transplant (in 1983-1984). 

WSJ: “After a historic 1984 consent decree forced the company to spin off its local phone companies, AT&T struggled with an ambitious mission on a battlefield that kept changing: trying to serve all its customers' transmission needs, business or residential, voice or data, cable or wireless.”

·        In the mortal throws of the beleaguered John Akers administration, IBM also tried to break itself up in the hopes of surviving a competitive onslaught by smaller, nimbler competitors (see “Battleship IBM” Broken Up! - Annex Bulletin 91-60, Dec. 5, 1991 - Appendix A of this report).  But one of the first decrees issued by the new IBM emperor, Lou Gerstner, was to announce that he would not break up the company (see Annex Bulletin 93-45, Sep. 22, 1993).

WSJ: “AT&T's announcement Wednesday that it would split into four distinct units closed an era in the telecommunications war, as its oldest combatant conceded defeat on its latest attempt at being all things to all people. "One system, one policy, universal service" was the mantra coined by the legendary former chairman, Theodore Vail. Before Wednesday's humbling retreat AT&T's current chief, C. Michael Armstrong, spent more than $100 billion on cable systems in a vain effort to achieve the same goal in the era of broadband information networks. Now, AT&T is finally acknowledging that it can't pursue that goal anymore.”

·        Sadly, “one system, one policy, universal service” is still very much in vogue at IBM today, the anachronism of this mantra notwithstanding in the current business environment.  A further difference between AT&T and IBM is that while Armstrong had spent more than $100 billion trying to buy his way into new markets, Gerstner has squandered almost $40 billion trying to buy an illusion of prosperity by way of Wall Street stock recommendations.

WSJ: “The story of AT&T's 115-year rise and fall illustrates two simple lessons of American capitalism. The first is that no company, however large and prosperous, is safe from the convulsions of social, economic and technological change… The second lesson began to hit home after 1984. When Ma Bell lost its local service, it lost a vital connection to its customers, millions of employees and the marketplace. No longer was it Ma Bell, everyone's mother who took care of her children's needs.  And with that loss came a decline in the political clout the company had always taken for granted.”

·        When the PCs, rather than “dumb terminals” connected to a mainframe took over the world, IBM also lost its vital connection to its customers.  So bad did the situation become, that the former IBM chairman Akers felt compelled to declare 1987, for example, “the year of the customer” (see Annex Bulletin 87-30, May 31, 1987). His goal, of course, was to remind the Big Blue’s self-centered bureaucrats what side their bread was buttered on.  It didn’t work.  All Akers accomplished was to draw attention to an IBM failure.  In fact, Digital Equipment Corp. (DEC), which back then looked as if it could walk on water, used a chance to run an anti-IBM advertising campaign with the theme - “at DEC, every year is the year of the customer.  “Finally, a frustrated Akers lashed out at his top officers in a fierce attack in May 1991, which went down in IBM history as a “water cooler” incident (see Annex Bulletin 91-30, May 28, 1991).

WSJ: “In its youthful days, the company was a model of cutthroat aggressiveness. In 1902, Bell was competing with more than 1,500 independent telephone companies. But because it controlled all long-distance lines, Bell could limit competitors' growth simply by denying them connections to the national network.”

·        All of the above applies to the early IBM days, almost to a tee.  So aggressive was the IBM “founder,” Tom Watson Sr. back then, that in 1913, he and his boss at his former employer, John Patterson of NCR, were fined $5,000 each and sentenced to a year in jail for antitrust violations (see Annex Bulletin 85-25, May 7, 1987, and “IBM: Colossus in Transition,” by Robert Sobel, 1981, page 13).

WSJ: “When the tide began to turn against the Bell monopoly in the 1960s and 1970s, the company was psychologically unprepared for the competition that was swarming into its industry. The company had begun to lose energy and put on weight. Its managers were experts at efficient operations, not futuristic visionaries, and the hierarchy was becoming as fixed as the steel and cement of an old plant. AT&T's cash cow, long-distance telephone service, demanded so much attention -- and paid so handsomely - that management had little appetite or incentive for innovation.”

·        Another observation that fits IBM to a tee. Just substitute mainframe in IBM’s case, for long distance in AT&T’s.  The only difference was that IBM mainframes and the associated software were a de facto monopoly, while AT&T was an actual, government-regulated monopoly.

WSJ: “As the 1980s loomed, demand for telecommunications was expanding too rapidly and becoming too complex to be served by the Bell System alone. People, especially in business, wanted more than voice transmission from their wires: They wanted to move and process data at high speed, too. With the development of electronic switching stations, microwave transmission and satellite communications, the technological justification for AT&T's monopoly disappeared.”

·        Bingo, again, as in IBM’s case!  It’s only that in the computer market, the PCs, Microsoft Windows and Unix servers sent the IBM mainframe business reeling the way all of the above innovations did AT&T’s monopoly in.  Finally, the Internet was the straw that broke the Big Blue mainframe camel’s back the second half of the 1990s.

WSJ: “The company [AT&T] has jumped with both feet into competition for other alliances, mergers and acquisitions…. AT&T has accumulated, mainly through acquisitions, a staggering $61 billion in debt, which costs the company more than $2 billion a year in interest. Long-distance telephone rates have been plummeting, and the company's lucrative but disorganized Business Services unit has been losing customers. The expected growth of "cable telephony" customers has fallen well below projections, and the company has failed to strike the deals it envisioned with other cable operators to augment its own system.

AT&T's penalty for these blunders: Its stock price is hovering around historic lows and the company has lost more than $70 billion in market valuation since January. The stock closed at $23.56 Wednesday (Oct. 25), down from a 52-week high of $61. "This is a sector of the economy that has been outpaced by technological change," says Phil Verveer, a partner at Wilkie, Farr & Gallagher in Washington, D.C., who was a member of the Department of Justice team that investigated AT&T in the 1970s. "The corporate culture of traditional companies like AT&T just couldn't adapt quickly enough".”

·        Amen to that! Count IBM in among such “traditional companies” that are having trouble adapting and growing again.  

WSJ: “Brian Adamik, an analyst with Yankee Group, said [about the four new AT&T units]… ‘these businesses have a tough road ahead.  The consumer unit is a dog, and business services and broadband are suspect. The only shining star here is wireless’.”

·        Translated into the IBM world, the PC and enterprise server units are dogs, and software and OEM are suspect.  The only shining star here is IBM Global Services.  And even it has lost some of its luster lately.

Summary

When we first issued our recommendation to break up IBM, we said: “And Now on to Next Phase for “Big Blue” Under Gerstner: How to Grow IBM?  Make It Smaller, Better” (see Break Up IBM! - Annex Bulletin 96-19, Mar. 20, 1996).  We argued that, “a blueprint for a $180 IBM stock (was) spinning-off and selling-off certain businesses, (which) could generate $43 billion of additional shareholder value.” 

At the time, IBM was stock was grossly undervalued, at about $23 per share (adjusted for subsequent splits), or just under $100 as actual 1996 share price.  If IBM management had followed through on our recommendation, IBM would have been a smaller company (about $46 billion in 1996 terms), but with nearly double the market value.

As it turned out, we were way too conservative.  Thanks to a bubble market of the late 1990s, even after a recent sell-off following IBM’s third quarter report (see Annex Bulletin 2000-23), the stock was still worth nearly four times as much as it was back in early 1996.  The price also soared due to more than $37 billion IBM had spent on stock buybacks, which induced Wall Street to ignore the company’s mediocre business results.

Text Box:  One reason for our break-up recommendation was the benefit of hindsight, relative to AT&T’s 1984 divestiture.  Advancing the clock now to the current time frame, the AT&T stock itself, valued at over $100 billion even at its present lows, has risen more than five-fold since 1984, the year the company was broken up by the trustbusters.

As to the so-called “baby Bells,” the local telephone companies, their market value has soared 12-fold during the same time frame.  

So relative to the value of the integrated Ma Bell system at the end of 1983 - $59 billion, the aggregate market capitalization of today’s Ma Bell and her “baby Bells” offspring has increased more than 10-fold  to about $624 billion.

The significance of all this was evidently lost on IBM leaders.  In August 1996, the IBM chairman, Lou Gerstner, called said our break-up proposal was “a dumb idea” (see “Louis XIX of Armonk, Annex Bulletin 96-42, Aug. 23, 1996).

Wonder what he is thinking now that even the staid, old Ma Bell has seen the light?  Early retirement may not be a bad topic. 

As the Wall Street Journal reported in its today’s edition, Fortune 500 CEOs are starting to “depart faster than ever as boards, investors lose patience.” Thirty-eight of the nation’s 200 largest public companies have replaced their CEOs in the first nine months of this year, up from 23 in all of 1999.

Should the IBM directors ever do what they are paid for - serve the IBM shareholders’ interests, not just those of the CEO - stand by for the greatest cheer among the IBM employees and investors since the closing ceremonies at the Olympics. 

Happy bargain hunting!

Bob Djurdjevic

APPENDIX A

(Annex Bulletin 91-60, December 5, 1991)

 IBM's "Restructuring" Details Revealed: Much Ado About Nothing

 THE "BATTLESHIP IBM" BROKEN UP!

 PHOENIX, Dec. 5, 1991 - IBM's "restructuring" has already produced at least one definite benefit: it has been a real media hit!  Otherwise, it was a "hit and miss" exercise, mostly the latter.  First of all, even the very expression "restructuring" overstates the case.  What IBM/Akers is doing is dividing up the company's operations along the existing LOB seams.  From a customer standpoint, some of whom are already regarding the IBM organization as a gigantic jig-saw puzzle, the latest announcements will mean a substantial increase in the puzzle's pieces.

Take the Enterprise Systems "restructuring," for example.  Earlier this week, we reported that Nick Donofrio will replace Carl Conti (see CMS BULLETIN 91-59, 12/02/91).  He will not.  Donofrio will replace Donofrio.  Only with a fancier title (LOB GM versus division president), and a new boss (Lautenbach versus Conti).  Similarly, Ray Abuzzayad will succeed -- well, himself -- as the head of IBM's Storage Products LOB.  In other words, Akers has broken up the "Battleship IBM," the line of business which used to be IBM's entire business, and still accounts for almost half of its profits and revenues.  One does not have to be an admiral to figure out that three gun boats will probably deliver less firepower than a battleship. 

By separating services from manufacturing, and emphasizing OEM sales, IBM is effectively removing its marketing and economic cover (i.e., the areas of its strength).  And it is playing right into the strength of the Japanese competitors.  If Akers' "strategy," therefore, appears to be one of getting out of these businesses.  Eventually, this could lead to selling off of IBM's manufacturing operations to more capable competitors.  Nothing in IBM's releases or statements today specifically stated that was a goal.  But, with IBM's defeat on a level playing field all but assured, we cannot conceive of any other reason for doing it.

Akers' Gesturing...

So what was the restructuring about?  It was a "do something"-gesture by the IBM chairman.  Akers seems to have felt the pressure, by the public opinion more so than by the Board, to show that he is willing to change things around.  In fact, however, what we saw today represented very little change in substance.  What change there was, it was probably not for the better.  So that we don't waste your valuable time repeating our arguments, please refer to our CMS BULLETINS 91-57, 11/26/91, for a more detailed explanation.

IBM's announcements also left many questions unanswered (such as specifics of strategy, or organizations), while offering some incomplete or contradictory answers.  It all points out to a hurry-up offense, with plays being called on the fly.

Take IBM's claim last week, for example, that $2 billion of its $3 billion write-off would be used for severance payments related to the 20,000 jobs IBM will be eliminating.  That's double the amount per employee IBM said it would cost two years ago!  And, as everybody knows, IBM's separation offers have been getting leaner all the time (i.e., common sense would suggest it ought to have cost less now than in 1989, not twice as much?!).  IBM's explanation?  The IBM spokesperson acknowledged the discrepancy, but could not explain it right away.  He promised to get back to us.  It's been more than a week since that time...

One Surprise: New Employment Solutions Corp. (ESC)

It looks as if IBM is trying to make a business out of its downsizing.  This new IBM subsidiary will provide the various personnel-related placement services -- first to IBM, then to other firms, too.  And, based on a number of American corporations shrinking their payrolls, this may be one promising opportunity.  The irony is, that it took a big screw up to create a good business opportunity.  Unlike the Acts of God or other external factors which derailed the U.S. steel, auto or appliance industries, for example, IBM's problem is of its own making.  It is like the Kuwaitis setting their own oil wells on fire so as to enter the firefighting business?!

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Volume XVI, No. 2000-24
October 26, 2000

Editor: Bob Djurdjevic
Published by Annex Research
e-mail: annex@djurdjevic.com

P.O. Box 97100,      Phoenix, Arizona 85060-7100
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