Secrets of Success: Interesting battle for M&S is on the cards

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The Independent Online

IF IT runs the full course, the bid battle for Marks & Spencer promises to be one of the most interesting of recent times.

IF IT runs the full course, the bid battle for Marks & Spencer promises to be one of the most interesting of recent times. It is too early to call the final outcome, though a fair summary so far might be that, for all its recent troubles, the battle is still one for the new incumbent management to lose, rather than one which Philip Green's team can win by force.

Even if the defence prevails in the end, the pressure on M&S to make radical changes is going to remain. History suggests that while managements get one chance to make amends for a poor period, they rarely get a second - and M&S are already on their second chance. From a long-term investor's perspective, the life cycle of successful companies is typically much shorter than most investors realise. However powerful its reputation, even a household name can run out of steam surprisingly quickly.

Whether General Electric (in the US) or M&S here, companies that remain market leaders for a century or more are the exception. The average independent life cycle of a quoted company is less than 30 years. Three years ago, Vodafone was the most valuable company in the UK market, yet it did not exist 20 years ago.

The most remarkable point about M&S is that it has sustained its market leadership for so long, despite operating in a sector of the market - retailing - where competition is particularly fierce and brand names are vulnerable to erosion as the generations pass and new fashions and enthusiasms emerge.

There are reasons in both business economics and management as to why the active life cycle of companies is so short. Almost without exception, the companies that do remain market leaders for two or more generations enjoy some form of monopolistic power in the shape of economies of scale, patent protection, or government regulation. The fatter the profits such monopoly provides, the greater the competition that eventually emerges.

Good management can often extend the life cycle of a company with good business economics, but it rarely sustains a business on its own. In practice, managements all too often become complacent or powerless to introduce necessary changes. A classic example was the failure of Western Union in the late 19th century to buy Alexander Graham Bell's telephone patents when they were offered them at a giveaway price - arguably the most expensive single corporate mistake.

Few retailers enjoy the kind of barriers to competition that an oil company or defence contractor at times enjoy. M&S has a wonderful portfolio of high street properties, but its success over the years derives from the loyalty of its customer base and their belief that the company's products are of sufficient quality to justify the premium prices the company charges.

That belief has been shaken in recent years. It is easy to criticise the company's bureaucratic structure and arrogance, but you should not underestimate how difficult it is to sustain the power of a retail brand in the face of changing fashions and social habits.

While some great investors such as Philip Fisher have prospered by buying good companies and holding them for years, it is rare for their successes to include many retailers. The roots of pricing power in retailing are simply too shallow for that.

Of course there are exceptions - Tesco is a good recent example - but the general principle remains. A plausible outcome of the M&S situation is that whoever wins, a break-up of the company will happen sooner rather than later.

The point that Fisher made is that in the right industry it is foolish to dump a proven quality company just because its share price has become temporarily over or under-valued. If you have spent a lot of time finding a strong company that meets all your criteria, trading in and out of the shares for the sake of a transitory loss or gain is unproductive use of your time. The most important thing is to make sure you are sharing in the progress of the company during the lifetime of its business success.

A truly great company will reward you more than adequately over many years, so there is no need to try and add the imagined but uncertain rewards of buying in and out. Fisher's most famous investments included Texas Instruments and Motorola, a company he first bought in the 1930s and still owned when he died at the age of 100 this year.

The catch in all this is that finding such companies is no easy task, for they are rare beasts. Warren Buffett has found fewer than a dozen he wants to hold indefinitely, after 50 years of looking. Fisher's portfolio was also heavily concentrated on just a few stocks in a few sectors where permanent pricing power is more likely to be found.

The question for M&S shareholders is not just about the relative merits of Mr Green's bid and whatever alternative value the defence can come up with. It may also be about whether M&S - which has undoubtedly been a great company in the past - still has the potential to be a great retailer again.

The other point that struck me this week is the paucity of the argument that the investment institutions will be reluctant to sell out to Mr Green's offer because they have sold other companies to him too cheaply in the past. Such an argument of course merely underlines the failure of the market to value companies correctly. An alternative view might be that it underlines the weakness of the institutions when it comes to imposing change on under-performing companies - something that Mr Green has no difficulty in achieving.

Although financial markets are clearly looking vulnerable to further shocks at the moment, you could argue that they have actually displayed a surprising degree of resilience in the face of rising oil prices, continuing unrest in the Middle East and the prospect of a series of interest rate rises in the pipeline.

The point I would make is that the interest rate rises are something that the market has had plenty of time to anticipate. They are not exactly news. And while the oil price increase is a genuine concern if it isn't sustained, there is still a chance that when the situation becomes clearer over the next few months we will see more strength in the market than most investors currently expect. That said, there is no reason to be violently bullish just for the sake of machismo.

jd@intelligent-investor.co.uk

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