Corporate Restructuring and Industrial Research and Development (1990) / Chapter Skim
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Morning Session, October 12, 1989
Morning Session, October 12, 1989
Pages 21-79
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From page 21... ...
There is undefined anxiety that the recent turmoil in financial markets is or may be disturbing many corporations' ability to pursue traditional long-term research. The Academy of Sciences, the Academy of Engineering and the Institute of Medicine worry a great deal about the health of the R&D enterprise In this country, whether in government or universities or in industry and, of course, that is the reason why through the Academy Industry Program, we have decided to organize this program.
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From page 22... ...
With you, Frank Press, my friend Roger Altman and me here today, it proves that there is life after the Carter Administration. I am also pleased that we have members of the Bush Administration who will be joining us.
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From page 23... ...
We no longer have a monopoly on quality in this country and we can only stay ahead by being at the cutting edge of change through increased research and development. There is a chronic systematic underinvestment in R&D by American industry.
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From page 24... ...
it is lower than Japan's, West Germany's, France's and even Italy's. Only through accelerated industrial research and development can we remain competitive and be at the cutting edge of change, staying ahead in the development of new products and production methods.
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From page 25... ...
For the purposes of today's symposium, we should define restructuring quite broadly. It is, of course, at the very least, leveraged buyouts, but it also refers to mergers and acquisitions, takeovers, both hostile and friendly, as well as internal restructurings, which most large corporations have gone through in recent years.
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From page 26... ...
We will then turn to two senior corporate executives: Mac Booth, President and Chief Executive Officer of Polaroid and Henry Wendt, Chairman of SmithKline, who will describe their respective companies' restructuring experiences and their likely impact on R&D. After lunch, the Majority Leader of the House of Representatives, Dick Gephardt, will outline how Congress might try to deal with this changing corporate landscape.
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From page 27... ...
It seems to me that restructurings are one part, and they are not the main part, of a larger financial trend in the United States, an economic trend, and a very negative one, which is the savings and investment crisis, the dearth of savings and investment, and its impact on the cost of capital. We have seen over the 1980s such sharp declines in private savings and in net private investments and such a widening divergence in the cost of capital for American industry, compared with that of our key trading partners, that restructurings, in my view, have been an inevitable consequence of those trends.
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From page 28... ...
Net private investment now, there are a lot of different ways of measuring net private investment, as Me Wall Street Journal almost endlessly pointed out to me. But net private investment, excluding housing, according to the Commerce Department figures, averaged 3 1/2 percent of GNP during this earlier 30-year period and it was quite steady in the fifties, the sixties, the seventies.
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From page 29... ...
I have seen some studies, including a very good one that Professor Ellsworth at Harvard did a couple of years ago, that equity returns in a variety of major U.S. industries have been more than 50 percent higher than the Japanese counterparts, and particularly using industries where most of the relevant assets are in the home countries.
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From page 30... ...
I think we had calculated the discounted cash flow valuation in this case, using about an 8 percent discount rate, which I think any of you in the corporate sector would say is a lot lower than you would use here in the United States. After a few hours of negotiating we had gotten essentially nowhere, having been told time after time that our offer was way too low and that the business was worth much more than that.
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From page 31... ...
They are, to some extent, in a different category because they relate to financial difficulties, but, if you will, you can include them in this topic as well. But the main types of restructurings I am referring to have boomed in the last few years because, of course, shareholders are no longer patient as they search for higher and higher equity returns over major value gaps: the differential between private market value or what Wall Street calls M&A
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From page 32... ...
The result, because of the sharply declining interest rates that we had from 1982 forward and because of the rising stock market over that same period, would have been about 70 percent average annual return on equity. The point is that leverage, together with the rising stock market, has permitted leveraged buyouts and many other types of corporate restructurings to work as well as they have.
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From page 33... ...
There will be more cases, for instance, like Quantum Chemical, a major producer of basic chemicals it used to be called National Distillers which several months ago voluntarily chose to recapitalize itself, pay a special cash dividend to its shareholders, to close the gap between its private market value or its leveraged value, and its then desultory stock price. I think you will see a lot more of that.
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From page 34... ...
They include not only giants like RJR Nabisco, Stop & Shop and Safeway, but also it&D-based corporations, like Duracell. Michael joined KKR in 1985 and since then has participated in numerous leveraged buyouts, financings, restructurings and dispositions.
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From page 35... ...
Yet, I think, strange as it may seem, on a macroeconomic basis, leveraged buyouts and restructurings may actually be an agent for increased research and development.
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From page 36... ...
Companies husbanded capital rather than disseminating it to shareholders and the financial markets, limiting redeployment into projects with higher returns. How is it that a leveraged buyout or a management restructuring opportunity can pay on average a 50 percent premium over the public trading value of a company?
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From page 37... ...
I won't do as well and my career may be impaired because the return may be five, seven, ten years off. Yet, when we do a leveraged buyout, management is building value for the long term.
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From page 38... ...
The definition of a leveraged buyout, similar to restructuring, is that a leveraged buyout is nothing more than a financing technique. Its name is driven by the fact that the acquirer usually borrows a large percentage of the purchase price, typically from a variety of sources, such as commercial banks, insurance companies and other sophisticated financial institutions or public purchasers of a high-yield financial instrument often called junk debt.
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From page 39... ...
Strong, predictable cash flows to service the financing costs related to the acquisition are critical. Readily separable assets or businesses which could be available for sale to provide flexibility are often necessary.
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From page 40... ...
R, we have calculated that a net tax benefit to the government, present value, was $3.2 billion, positive. The Kaplan study, looking at the RJR transaction alone, shows a net present value to the government in tax revenues of $3.8 billion, for a total of that present value benefit to the government treasury of $7.0 billion as a result of leveraged buyouts that we did.
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From page 41... ...
Well, relative to our trading partners, we are the least leveraged. As a matter of fact, on a market value basis, debt to equity, we are at a 57 percent ratio today, the lowest ratio of debt to market value of equity in the last 20 years.
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From page 42... ...
The risk of default on such transactions varies from company to company and from industry to industry, but is generally dispersed." In closing, I would like to comment on one thing and that is that we are going through a period of change in the financial markets, that the inefficient public corporations are under pressure to change, and are being forced to do so. Heretofore, inefficient companies had little impetus, few outside factors to affect them.
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From page 43... ...
But I did not intend to say, because I don't believe it, that restructurings are vital to the health and future vitality of American industry; quite the opposite. I jUSt said that restructurings are a consequence of broader savings, investment and cost of capital trends, which are really quite negative for American industry and for the competitiveness of this country and ultimately for the most important goal all of us have, which is rising standards of living for our citizens.
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From page 44... ...
I think, like Roger, that they are by-products of some gross inefficiencies, particularly in the capital markets and particularly in our entire economic integration between government and the private sector.
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From page 45... ...
Not only did they survive what would be catastrophic for most companies in terms of the four-year period, but they came out and flourished, acquiring another company 50 percent of their size and now are actually public on the New York Stock Exchange. So, to answer your question in a straight-on manner, manufacturing companies are actually very good potential buyout candidates for us, or for restructurings of any type.
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From page 46... ...
In terms of CEOs, in our companies on average the CEO owns 6 percent versus a public corporation where the CEO owns less than a quarter of 1 percent.
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From page 47... ...
I am no expert on Houdaille, but it is important to understand that leveraged buyouts, by their very essence, at least most of them, are designed to eventually be liquified, as I mentioned in my comments, by the organizer, by the equity investor. So, the notion of selling all of the company, as happened in Houdaille, is exactly the point of ordinally organizing the buyout.
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From page 48... ...
And, by the way, the change of corporate control from us to the TI Group had in no way a negative impact on the employees of that corporation, its health or its future. It was a simple change of ownership, which occurs daily on the stock market: The shares of many of these companies out there change significantly every day; General Motors shares, IBM shares trade all over the place, and it does not affect the basic company.
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From page 49... ...
We did a leveraged buyout and we sold that company to the management.~ I was shocked when I saw management's budget for operating profit of that company a year after we sold it to them. When I had the company, Beatrice had $120 million of operating profit, of which $40 million was really Max Factor.
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From page 50... ...
Mike pointed out the very, very basic difference between the public corporation format and the private corporation format, and Professor Jensen has published a piece, which is really very provocative and I commend to all of you, arguing that for a lot of underlying long-term reasons, the day for many corporations where public ownership was the most efficient form of ownership is over. That has to do with access to financing that private companies now have that they didn't used to have, and with the way the capital markets have evolved; it is no longer necessary to be publicly owned, for instance, to finance a business efficiently.
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From page 51... ...
I think in Beatrice it was down to approximately 250 or 300 people. In some instances we stimulate ownership through delivery of the unit that literally mimics or mirrors the stock ownership that the individual investors have at the higher levels.
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From page 52... ...
The improved operating profit of the business, together with the fact that previously it was unleveraged, permit the enterprise to move forward and the equity investors ultimately to prosper without asset sales. So, it just isn't the case that it is a requirement of every transaction.
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From page 53... ...
MR. TOKARZ: I think it is natural to assume that if you are leveraged and you must husband your individual dollars and cents, that you are going to deprive other areas where if you had excess cash flow, you would deploy it.
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From page 54... ...
I obviously believe it is not and I don't believe that private ownership is the long-term benefit for this country. I believe public scrutiny is important and I believe there should continue to be public scrutiny for public corporations.
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From page 55... ...
In fact, they reduce profits and they reduce cash flow in those years. Heavily leveraged companies require large cash flows to meet the huge interest payments on their increased debts, and in situations where a public corporation is taken private, not only is there usually a large debt payment, there is also a need to make the company appear profitable.
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From page 56... ...
How important is the role of research in our vision of the future and what is the potential return for our shareholders now and in the future? Research becomes one of the three or four focal points of attention by all parties in a hostile takeover or leveraged buyout situation.
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From page 57... ...
Science and technology had in a major way won the war and science would now pave the way for a great American business resurgence in peacetime. Vannevar Bush and Edwin Land had never heard of a leveraged buyout.
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From page 58... ...
Indeed, at the same time that our research activities were being attacked externally by Shamrock Holdings, they were being examined and reexamined in great detail within the corporation itself. In Polaroid, the takeover threat was the ultimate confrontation with the future and the rapidly changing world we live in.
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From page 59... ...
I don't think that the raiders and the leveraged buyout kingpins are wrong when they demand that corporations look at their R&D spending. If there are lasting lessons to be learned from the Polaroid experience, they relate to how we conduct our research, as much as what we choose to invest in.
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From page 60... ...
Henry Wendt is Chairman of the Board of SmithKline Beecham. He joined SmithKline in 1955, shortly after receiving his B.A degree in American diplomatic history from Princeton.
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From page 61... ...
I will attempt to make the following points to you this morning. First, I will characterize SmithKline Beecham's status in the world of corporations and describe our recent merger.
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From page 62... ...
What is it and how did it get to be that way? It is, of course, a research-intensive, indeed, a technology-intensive corporation, in contrast to at least some of the companies characterized in this morning's discussion as the ideal targets for leveraged buyouts, which are perhaps the most dramatic form of corporate restructuring.
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From page 63... ...
Our competitors and, again the Japanese are a notable example patent their discoveries in the United States and in other countries, as well as their homeland. SmithKline Beecham, likewise, patents our discoveries in all the attractive marketplaces, including Japan.
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From page 64... ...
And matching our R&D to the global market is one of the keys to understanding SmithKline Beecham and our approach. The price of admission to the world league of pharmaceutical discovery is an annual R&D investment now of at least a half a billion dollars.
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From page 65... ...
It pointed out that an American-only consortium of computer and telephonic companies, particularly one financed by the military, hardly seems best suited to develop hot-selling consumer goods, like high-definition TV Perhaps such efforts will succeed, but I fear for any national consortium that does not fully appreciate the global marketplace. My conclusion is that the observed dip in R&D funding may be a temporary phenomenon.
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From page 66... ...
Nevertheless, I am convinced that the short-term investment horizon does demand emphasis on quarter-to-quarter earnings and forces corporations to think short term, while R&D, by its nature, is a very long-term process. The American financial markets are geared to short-term investment.
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From page 67... ...
That is a personal judgment, not something that necessarily is accurate. So, I ramble a little bit, but let me just say that there is no question that there was a stimulus there.
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From page 68... ...
Do you think currently or recently that your stock has been undervalued by the U.S. stock market as a result of your R&D expenditures?
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From page 69... ...
In the ivory towers and among the policymakers, there is something inconsistent about those two views. Myopia the problem of a stockmarket that does not appreciate long-term research and development, that discounts it, overdiscounts it is precisely the kind of a condition that will lead to excessive restructuring, will lead to a substitution of debt for equity, will lead to privatization, leveraged buyouts and a sacrificing of research and development.
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From page 70... ...
It has to do with the growth of transnational corporations and national advantage. Let me define national advantage as an increased standard of living for our people, which says that we should continue to attract manufacturing and also R&D, whether they be from U.S.
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From page 71... ...
What we have heard here are two people talking about industries that are vital and need technology renewal, which is really the subject of this symposium. Now, my thesis is that the short-term investment horizon is, in fact, the problem.
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From page 72... ...
Wendt a question, which is an extension of his comments on globalization or transnational companies, and that is really the concern about the global management of R&D. You just talked about R&D, but the question is, as you become more global where do you do what research and why?
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From page 73... ...
MR. WENDT: Well, it is a very pertinent question for SmithKline Beecham in that as a consequence of the merger of these two very large companies, we are examining everything that we do with an eye to the future rather than to the past.
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From page 74... ...
~ think that we can just sort of erect national boundaries in this day and age, I think is wrong.
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From page 75... ...
Now, SmithKline Beecham, more than SmithKline or Beecham prior to the merger—and I dare say, perhaps more even than Pfizer has sales and profits that on a proportional basis match more closely the global market. I mentioned that Europe is the larger market, followed by the United States and Japan.
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From page 76... ...
He decided to see if he could come up with some explanation for why the performance of Japanese manufacturing companies had been so far superior to American manufacturing companies during the last 15 years. His measure of this was that the Japanese have gained market share and the American companies had lost market share.
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From page 77... ...
We are now spending about 20 to 22 billion dollars a year in public money on non-defense-related research and development, about 6 billion of which goes for purposes that lie at the root of your own industry, the biomedical research at NIH and elsewhere. A lot of the argument about why that is a good investment of United States citizen-taxed public funds, or borrowed public funds, is that it will enhance the competitiveness of American firms in the competition with
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From page 78... ...
Or are we, in fact, on the verge of having to reexamine the relationship of the transnational corporation to the independent nation-states? Do we need new parallel structures of governance, so that there continues to be some overlap between the geographic domains of industrial operation and those of taxing, spending, employment and unemployment?
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From page 79... ...
I am not an expert on the Japanese marketplace or Japanese industry. I can speak about my own experience and our own corporate experience in electronics and in photography.
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