Firing workers isn't fixing problems

By Jim Jubak

Fire more workers.

That's the solution offered by the CEOs of Motorola (MOT, news, msgs) and Pfizer (PFE, news, msgs) to the problems at those companies. Shortly after announcing disappointing earnings for the December 2006 quarter -- a drop of 31% from 2005 for Motorola and a decline of 16% for Pfizer -- the companies announced plans to cut 3,500 jobs and 10,000 jobs, respectively.

Both CEOs, Edward Zander at Motorola and Jeffrey Kindler at Pfizer, of course, kept their jobs and their paychecks. According to Motorola's latest proxy statement, Zander received a salary of $1.5 million, a $3 million bonus and $2.3 million in restricted stock in 2005. Kinder has only been on the job since last July. Before that he was vice chairman and general counsel, with an annual compensation package worth $3 million, according to Forbes. He was brought in to revive a company that had slumped under his predecessor, Henry McKinnell, who received a retirement package of $180 million.

For this kind of money, investors -- let alone the workers who are being fired -- deserve something a little more imaginative as a turnaround strategy. Cutting jobs has become a reflex, not because it works especially well at fixing the real problems at companies like these but because firings produce the kind of immediate earnings improvements that help CEOs keep their jobs.

Getting rid of workers, you see, lets a company forecast the kind of immediate cost savings and surging profit margins that keep shareholders from marching on the executive suite. Pfizer threw shareholders an even bigger bone by authorizing $10 billion in share buybacks in 2007 and promising further increases in the company's dividend payout.

None of this has anything to do with fixing the problem facing both two companies: a failure to innovate. Neither company has been able to figure out how to come up with a steady stream of new products -- despite spending big on research and development -- to replace aging big sellers facing crushing competition. You could even argue that firing 5% and 10% of your work force, as Motorola and Pfizer did, throws a company into turmoil just at the time when it needs everybody to pull together.

Unfortunately, Motorola and Pfizer are pursuing an all-too-common strategy these days. Companies are long on financial engineering, cost-cutting, share buybacks and acquisitions, but short on innovation and capital spending today to generate profits tomorrow. That will change, but until it does, investors will find themselves looking at a landscape like the current one, a landscape that's very, very short on great growth stocks.

Early ripe, early rot

So what's wrong at Motorola? Pretty much the same old thing that Zander was brought in to fix. The company can create great individual products, such as the Razr phone, that sell like hot cakes when they first hit the market. But the company can't create a steady stream of new items to keep its product line fresh and competitors chasing a moving target.

The result is that profit margins on even great products such as the Razr start to fall. Sales for the company's mobile device division, the company's biggest business, climbed by 19% as the company shipped a record 66 million handsets in the fourth quarter, up 47% from the same quarter in 2005. But operating earnings for the mobile devices division fell by 49%.

The bottom line was that Motorola sold a lot of phones -- enough to pick up about a percentage point of global market share in the quarter and to give the No. 2 wireless handset company -- behind Nokia (NOK, news, msgs) -- a 23% share. But with prices down about 16% on average from the fourth quarter of 2005, according to IYSKE Bank, those sales were less profitable. Operating margins fell to about 5% from 12% in the third quarter.

Motorola told investors it expects to see margins climb back to 10% in 2007 in the mobile devices division. If it achieves that, earnings in 2007 will come in around $1.20 a share, essentially flat with 2006. Not exactly what a growth-stock investor is looking for.

And, of course, there's no guarantee that Motorola can pull that off. The company does have what looks to be a strong lineup of new products for the second half of the year, but they will be competing against new products from Sony (SNE, news, msgs) and Samsung Electronics (SSNLF, news, msgs) as well as Apple (AAPL, news, msgs). Nokia has shown that it's willing to cut prices to keep market share. Under the circumstances, Wall Street investment houses are projecting lower operating margins. Kaufman Bros., for example, has lowered its 2007 estimate for mobile-device operating margins to 5.9% in 2007 from an earlier projection of 6.4%.

But even if Motorola and CEO Zander do pull another Razr out of their hat, it seems the company is still stuck in a boom-and-bust cycle. Steady growth is an elusive goal.

You need something to sell

Innovation, or the lack of it, also is at the core of Pfizer's problems, but at Pfizer generating solid future growth may be even more of a challenge. The company has never been especially good at finding new drugs. Instead, it built its growth record on the strength of a best-in-the-industry sales force.

These guys and gals were so good -- they had so much market clout -- that other drug companies were lined up around the block to have their newest discoveries turned into blockbuster products by Pfizer. And if the drug's potential was big enough, Pfizer would acquire the other company lock, stock and test tubes.

That's what happened with cholesterol drug Lipitor. The best-selling drug in the world started out as being jointly marketed by Pfizer and Warner Lambert until, in 2000, Pfizer bought its marketing partner outright. Same with another blockbuster, arthritis drug Celebrex, added to the Pfizer stable when the company acquired joint marketing partner Pharmacia in 2003.Unfortunately for Pfizer, the big-sales-force model isn't working so well anymore. Partly that's a result of more big drugs going off patent and a dearth of new blockbuster drugs coming to market.

There are simply fewer potential blockbusters to feed into Pfizer's marketing machine. And when there is, it's being fought over fiercely by every big drug company. If it's a potential drug from a smaller biotech company, it's being acquired earlier in the testing process. All of which means fewer drugs for Pfizer's sales force to market, more expensive acquisitions when a potential blockbuster does become available and more failures when a drug candidate goes from promise to flameout before it gets to market.

It's a fact of life, for individuals as well as companies, that we tend to keep pursuing strategies that have been successful long after they've stopped working. Pfizer fell victim to exactly that common failing. Its huge sales force wasn't yielding the returns to the company that it had in the past, so in an effort to fix the problem, Pfizer added more sales people.

The job cuts announced by Pfizer CEO Kindler are an effort to reduce that bloat. As Ian Read, president of the company's worldwide pharmaceutical operations, put it when Pfizer announced the cuts, the goal is to take the company back to its 2003 headcount, before the merger with Pharmacia.

But the cuts won't just affect the sales force. About 2,900 jobs will come out of research and development through the closure of three research sites. That's the second reorganization of the company's drug research program in less than two months: Kindler had announced the first overhaul after the company was forced to cancel development of torcetrapib on safety concerns. That drug was designed to be combined with Lipitor to extend the life of the company's blockbuster.

Although Pfizer is cutting research and development staff, it won't be cutting research and development spending, which is set to stay approximately steady at $7.5 billion a year. Good thing too, since CEO Kindler has committed the company to launching four internally developed drugs a year annually by 2011, to go with the launch of two externally acquired drugs a year.

As with Motorola's plan, there's no guarantee that Pfizer's effort will work. Revenue growth in the drug industry as a whole slowed to about 7% a year in 2004-2005, according to Standard & Poor's. That's after a decade of double-digit revenue growth.

And it's not like Pfizer is ramping up research and development spending from nothing, either. The company spent $7.4 billion, or 14.5% of revenue, on research and development in 2005. That's essentially the same as the 2007 budget. Pfizer now has a pipeline of 170 novel drug candidates, but it's tough to predict how many of these will turn into viable drugs and how many will become the kind of big sellers that Pfizer's sales force used to thrive on.

It's safe to say at this point is that Pfizer is, like Motorola, another former great growth stock where growth has become very unpredictable.

Who can pump it up?

If you survey the stock market landscape, you'll find more former predictable growth stocks that now offer the same uncertainty that Pfizer and Motorola do. That, of course means that an investor shouldn't pay the same high price-to-earnings ratio now for the less predictable growth of a Coca-Cola (KO, news, msgs), a Citigroup (C, news, msgs), an Intel (INTC, news, msgs) or a Dell (DELL INC., news, msgs).

And it means that the relatively fewer growth companies still pumping out predictable double-digit growth, such as a Procter & Gamble (PG, news, msgs) or a PepsiCo (PEP, news, msgs), deserve a higher multiple.

The most interesting -- and potentially most profitable -- cases are those once-great predictable growth companies that are now on the cusp. Will a company such as McDonald's (MCD, news, msgs) return to the ranks of those companies able to produce predictable double-digit growth? Should investors think of Cisco Systems (CSCO, news, msgs) as belonging to this category? And is Johnson & Johnson (JNJ, news, msgs) going to defy skeptics and keep pumping out that growth?

Sometimes it feels like the universe of great, predictable growth stocks has become very small indeed. But, fortunately, investors are witnessing the emergence of a new generation of growth stocks in the developing economies of the world. That's a topic for another day, however. Say, in about two weeks.

New developments on past columns

"5 buys for a fourth-quarter rally": There's no place to hide, but a few spots in the supply chain do provide some shelter from the storm. In 2006, the average selling price for a 42-inch LCD television fell by almost 50%, according to iSuppli. That crushed profit margins at the companies that manufacture the sets. Corning (GLW, news, msgs), which supplies the glass for screens to set makers, certainly didn't escape the squeeze on prices as selling price for its glass tumbled in 2006. But the decline was a relatively less punishing 20%, according to Pacific Crest Securities, and that difference was enough to enable Corning to beat Wall Street estimates by 3 cents, or better than 10%, for the December 2006 quarter.

On Jan. 24, the company reported earnings of 31 cents a share, up from a 2 cent a share loss in the fourth quarter of 2005. Revenue climbed by 14%. Corning isn't out of the woods yet, since the first half of 2007 is likely to be weak because of typical seasonal weakness in the first quarter -- when Wall Street is looking for just 7% earnings growth -- and continued pressure on glass and TV set prices. Indeed, the company cut its guidance for the first quarter of the year by a penny and predicted a 10% to 15% drop in display volumes. As of Jan. 31, I'm extending my target price of $28 from June to December 2007. (Full disclosure: I own shares of Corning in my personal portfolio.)

Meet Jim Jubak at The Money Show

MSN Money senior markets editor Jim Jubak will appear along with many other top investment professionals at The World Money Show in Orlando, Fla., Feb. 7-10.

Admission is free for MSN Money users and includes Jubak's seminars and access to more than 320 workshops, panel discussions and other sessions, as well as a chance to visit more than 350 top financial product and service providers in the exhibit hall. For complete details or to register for free admission, call 800-970-4355 (mention priority code #007420), or visit the Money Show Web site.

Editor's Note: A new Jubak's Journal is posted every Tuesday and Friday. Please note that Jubak's Picks recommendations are for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest-rate environment, see Jim's new portfolio, Dividend stocks for income investors. For picks with a truly long-term perspective, see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.

E-mail Jim Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Corning and PepsiCo. He does not own short positions in any stock mentioned in this column.