Corporate Investors are Ignoring Long-Term Stability for Easy Debt

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A recent article in the New York Times illustrates a wider issue across the corporate world which has developed in the last 10 to 20 years, not just in the US but increasingly across most western markets.

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The story starts fittingly in America’s heartland with two businesses run as one under the banner of the family name Timken. Old man Henry Timken, a carriage maker, moved his bearing business to Canton, Ohio, from St. Louis in 1901, anticipating the growth of the auto industry. Steel was added with a specialty in the grades needed for the bearing business and later in the oil industry and other specialist applications.

Traders in LondonThe Timken family are still there 117 years later and their support keeps the city of Canton functioning better than the nearby city of Akron where Goodyear pulled out after nearly 100 years making tires. Timken is not just about jobs and salaries, crucial as those are.

Over the last 5 years, the Timken family, foundation and company have given hundreds of thousands of dollars to the city’s biggest hospital, and at least $3.5 million to ArtsinStark, a private arts council that supports Canton’s art museum, ballet, symphony and other cultural institutions. In fact, the Timken Foundation built Timken High School in the late 1930s, the paper reports and the foundation poured $10 million into the school from 1997 to 2002 after graduation rates plunged. The district used the money to pay for new math and science programs as well as to renovate the campus.

The article strikes a balanced stance, it stresses the Timken family have, in turn, earned handsomely out of their ownership of the business over the years. They are certainly not bleeding heart liberals but staunch republicans, but republicans of an older hue maybe with an almost paternalistic sense of responsibility to the community in which they live and work.

The point the Times is trying to make in this article is not the rights or wrongs of Timken’s philosophy, more that it, along with much else in corporate America, the firm is at risk from the short-termism that has become the prevailing wisdom over the last 10 to 20 years. Shares in Timken were bought up in 2012 by an activist investor called Relational from San Diego.

Relational along with support from the California State Teachers’ Retirement System, known as Calstrs, mounted a year-long campaign to “unlock value” in Timken’s underperforming share price. Timken carried very little debt, partly because the family felt that gave them a cushion during the notoriously cyclical down times in the steel industry. But activist investors like debt, whether to make acquisitions or to increase dividends and finance large-scale stock buybacks.

The investor felt the 2 firms would be worth more apart and in fact, Relational’s model for a broken-up Timken suggested the 2 resulting pieces could afford to take on just over $1 billion in fresh debt the paper said. Debt that could be used for share buybacks and boost the share price – not in the investors’ view – for investment.

Bill George, a Harvard Business School professor is quoted as saying, “Activists think long term is 12 months and the first thing that goes is the stuff that pays off in 5 or 10 years,” adding “America’s strength isn’t from low labor costs. It’s from research and development and capital investment.”

You cannot do that stuff on a short-term focus and while financing a mountain of debt. As a result of the investor’s pressure, Timken duly broke into 2 firms. One was TimkenSteel making high-end steel, the other Timken bearings. Whilst it has one of the most modern slab casters in North America and operates profitably in it’s niche, the steel division is now ripe for a takeover by one of the majors, with the cost-cutting and rationalization that will inevitably be part of that process.

Meanwhile, Relational has unloaded its entire position in both Timken and TimkenSteel. Relational acquired its stake at about $40 a share and sold at $70, reaping a 75% gain — $188 million — in just over 2 years. The firm hasn’t done anything illegal, arguably it hasn’t even done anything immoral, it has simply operated within the rules of engagement we have all come to expect and accept as normal in today’s world.

Yet, as year-end approaches so to does that time to step back from day-to-day work and reflect on the wider environment in which we work, and maybe ask ourselves, is this the kind of behavior we want to encourage? Could there not be a better way? The people of Canton no doubt think there could be as they look at a new year that holds less job security than at anytime for the last hundred years.

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