The Diversification Debate

Companies continue to stumble over whether, and how, to diversify.

Indeed, three days after the attacks, GE quickly produced a preliminary estimate of the net loss to its insurance division–$600 million. “We want to give investors some measure of assurance [by] providing the best estimates we can make at this time,” said CEO Jeff Immelt. But if the move was meant to assure investors that the losses were manageable and contained within a single division, it backfired, forcing GE to remind investors a week later that it was on track for double-digit earnings growth despite the insurance hit. But any soothing effect that announcement may have had was undermined by the added mention of the “manageable” impact on GE’s airline business, and the mention of anticipated cutbacks by NBC advertisers. In the two weeks following the attacks, GE’s stock fell by 28 percent–twice as much as the Dow’s 14 percent dip.

In fact, investors prefer a company to be totally immune to the business cycle–something, of course, that is rarely achieved. One exception seems to be Bristol-Myers Squibb, which experienced no trouble whatsoever issuing $5 billion in medium- and long-term bonds in late September, the largest by an investment-grade company in the two weeks following the attacks.

Bristol CFO Fred Schiff says he and his finance team spent a great amount of time and energy in the months preceding the deal explaining to analysts and credit agencies how the proceeds would be used, and he describes the offering as “the proof of the pudding.” But it didn’t hurt that Bristol depends heavily on sales of pharmaceuticals, which have held up well despite the downturn in the economy.

That suggests that diversification won’t help unless virtually all of a company’s business is recession-proof. More evidence? Consider wine and spirits maker Constellation Brands, which easily raised $97 million in a secondary equity offering two weeks after the terrorist attacks. While September proved to be the first month since December 1975 in which not a single initial public offering went to market, and secondary offerings were few and far between, Constellation was able to raise the money through a single underwriter, Salomon Smith Barney. Although the road show that preceded the offering was suspended for a week because of the attacks, CFO Tom Summer reports that the deal ended up being oversubscribed fivefold. And the offering was no less successful than another equity deal by Constellation, this one for $120 million, only last February. “We’re lucky to be in a business that’s healthy,” says Summer.

So is BJ’s Wholesale Club Inc., the retail-buyers-club chain. “About 75 percent of what we sell, you would also find on grocery store shelves,” says CFO Frank Forward. As a result, he adds, “we are going to continue with our plan to open 13 to 14 stores next year.”

To be sure, the stock was actually in decline before the attacks, closing near $46 on September 10, down 19 percent from mid-July. No surprise, then, that BJ’s plans to add as many as 25 gas stations. Diversification? Not really, explains Forward. The gas stations–which are co-located with stores–are more about pumping up existing business. “We sell gas at 8 to 10 cents below the market,” he explains. “We don’t make much money on it, but it drives incremental membership and sales.”


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