Verizon’s speculative foray into the media business—with its recent acquisition of Yahoo and previous acquisition of AOL—has certainly garnered a lot of skeptical commentary. But what people seem to have forgotten is that such moves are nothing new for the carrier, which has a history of doing two things that many companies find incredibly difficult.
The first is to use what I call “healthy disengagement”—that is, getting out of businesses that are not solid growth engines. The second is to make investments across a portfolio of opportunities, in which some need to be valued not as conventional investments, but rather as bets one plays in the present to create future opportunities.
Companies resist disengagement
Let’s start with the disengagement process. In most companies, when a unit loses its competitive edge, especially if it is throwing off generous amounts of cash, the idea of making a timely exit is close to heresy. Investors don’t like the idea of giving up a unit that spins off cash, particularly if a company is then using that cash to invest in more uncertain—if potentially higher-growth—markets. So companies hang on and put their investment dollars into playing defense until the painful, inevitable denouement.
Then when a disengagement does happen, it’s painful, often slow, and just as unpopular with analysts as an earlier, healthy disengagement might have been. For instance, citing changing consumer preferences and the threat of on-line retailers such as Amazon (AMZN), retailers ranging from Macy’s (M) to JC Penney (JCP) to Best Buy (BBY) are shrinking their footprints and closing stores later than they probably should have.
Such divestitures are often so painful for the parent company that it takes an activist investor and board pressure to force management’s hands, as was the case with the Darden Group’s (DRI) Red Lobster chain and its real estate holdings. In that case, the pressure from the activists resulted in the entire board being fired en masse and set the stage for a resurgence in growth.
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Consider the contrasting case of Verizon (VZ), which navigated this process in the mid-2000s. Its leadership team, with Ivan Seidenberg at the helm then, decided to sell its slow-growth but cash-generating phone book and land-line businesses in what was described as a “gutsy” bet to transform the telephone operator into a fast-growth player in the rapidly growing digital arena. Investors were skeptical at the time, a factor that makes healthy disengagement so difficult for many CEOs.
With the wisdom of hindsight, Seidenberg’s move to position the company as a leader in fiber-optic cable to the home, superior wireless networks, and services such as bandwidth-hungry television programming looks like genius. It is a textbook case of disengaging while the underlying assets still have value to other buyers.
Keeping an eye on the portfolio
Here we are, a dozen or so years later, and Verizon faces new challenges, among them the threat of becoming a “dumb pipe” that is forced to invest in building and maintaining its networks as over-the-top services such as video streaming garner the lion’s share of revenue in the broadband arena.
Ironically, once again we are reading headlines about the “risky” gambles that Verizon is making in entering new arenas that take it away from its traditional core businesses, like the acquisition of content providers such as AOL and Yahoo and other investments in new and non-traditional businesses.
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That’s not the case at all, according to current CEO Lowell McAdam. The moves are intended to leverage Verizon’s significant network footprint, both in fiber-optic cables and in sophisticated wireless technologies. Owning media properties will allow the company to attract customer views, which in turn shows the promise of being able to more precisely track what those customers are doing and where they are doing it.
That should allow Verizon to make great strides in local advertising, which, with its promise of precisely pinpointing customers’ physical locations, is something of a holy grail. While its reality has eluded many would-be contenders for years (including AOL itself, which lost money on its local news service Patch), its time is soon to arrive.
I would argue that what McAdam is doing is what every leader who takes a long-term view should do. There are investments that one makes to keep the core business healthy, like Verizon’s continued significant investment in networks and network maintenance. Then there are investments that one makes to create the next-generation of core revenue. Often expensive and significant, these ensure that the company has a pipeline of new competitive advantages to build upon as older ones fade.
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Finally, there are investments that are made to create options for the future. Unlike a core investment in which returns can be calculated using tools like the net present value rule, options can only be looked at in terms of their potential upside versus downside. Trying to use conventional methodologies to value their future benefit to the corporation will almost always lead companies to under-invest in the innovations that might represent their salvation in the uncertain years ahead.
In a healthy portfolio, a certain amount of money is set aside for options, those investments that are not of the ‘bet the company’ type but which open opportunities to see and potentially create the future. While the billions Verizon has spent on media properties look like an awful lot of money (over $9 billion between AOL and Yahoo), as McAdam says, it’s only 5% of its massive capital spending budget.
That’s money the company can well afford to spend to create a window on the future.
