While 2011 may be the year the market gets back in gear, a lot of sizable companies look almost certain to struggle next year and over the long term -- because of bad bets, misguided merchandising or outdated products.
Take Vonage (VG). You might remember the quirky TV ads from this Internet phone company about how "people do stupid things” but shouldn't pay too much for phone service. They blitzed the airwaves a few years back, then dropped out of sight. Vonage itself may do the same before too long.
The company was a leader in cheap "voice over Internet protocol" phone service in the early days of that technology. But now, competitors like Google (GOOG), Skype and magicJack offer cheaper -- even free -- Internet phone service. This means that Vonage rates, typically $29 a month, may now be the ones that are too high.
Sales and subscribers declined in the last quarter as a result, a trend that might make it tough for Vonage to survive, believes Scott Stevens of Strata Capital Management, a hedge fund that was up 14.2% this year as of the end of October, compared with 7.9% for the S&P 500 Index ($INX).
Vonage responds that phone and cable companies charge much more for international phone service, so it can take customers from them. And it says it offers features that make its service competitive against lower-priced ones, and help explain the positive business trend of declining customer defections. These include voicemail, free 411, three-way calling, free number portability, 24/7 customer service and unlimited calling to 60 countries. The company also notes that cost-cutting and better efficiencies have dramatically improved cash flow.
Insiders, including CEO Jeffrey Citron, are big sellers, though, getting rid of 2.2 million shares so far this year.
Sears Holdings (SHLD) continues to stumble. Sales at stores open more than a year declined 8% in the third quarter. Shoppers continued to favor competitors like Wal-Mart Stores (WMT), Target (TGT) and Kohl's (KSS) over Sears and Kmart, which merged in 2005. "They can't seem to get their merchandising act together," says James Angel, professor of finance at Georgetown University's McDonough School of Business.
Sears, which was also on a list of "companies that may not see 2020" I made a year ago, almost implicitly conceded its stores have problems by recently deciding to sell Craftsman tools and DieHard batteries through other retail channels.
A potentially bullish side to this story is that Edward Lampert, who's got a reputation as a savvy investor, still owns about 60% of Sears through his hedge fund ESL Investments. On the other hand, he's had years to turn this retailer around since saving it in 2004, to no avail. If current trends continue, not even a DieHard will be able to jumpstart this retailer.
RealNetworks (RNWK) sells online games, music and video downloads, ringtones and media software like RealPlayer. It also owns a 47% stake in Rhapsody, a subscription-based online radio. Its big challenge is that all of these things are offered, often for free, by a lineup of tough competitors. They include giants like Apple and Facebook, but also Pandora and iheartradio -- free online radio services that compete directly with RealNetworks' Rhapsody pay service.
So, as you might expect, revenue declined in the third quarter -- by 10.7% to $86.4 million, after accounting adjustments. The company has a done a good job of cutting costs, and it does have a bundle of cash, $329 million. But the cash is dwindling, and further revenue declines are in store.
RealNetworks recently bought a social-games company, and it hopes to make money by offering cloud computing to help consumers manage their media over the Internet. "Under new leadership," says a spokesperson, RealNetworks is "working to simplify and restructure the company around core strengths that align with key trends of the emerging digital media landscape." The company says it is well-positioned because it can build on a large customer base of 38 million subscribers to media software services, and 40 million people who enjoy its online games. Insiders, though, are selling stock.
Back in 2003, I predicted Blockbuster would fall to an inexorable shift to new ways of delivering movies to the home. That played out when Blockbuster declared bankruptcy in September, and now it looks as though digital delivery of books, music and movies may hand Barnes & Noble (BKS) a similar fate.
Of course, there will still be bookstores a decade from now, and some may bear the Barnes & Noble logo. But the company is going to look a lot different. The business simply has too much overhead linked to brick and mortar stores, plus too much debt, to survive the ongoing consumer migration to online without a dramatic restructuring, Stevens says.
Barnes & Noble hopes to ride the e-reader wave with its own offering, the Nook. Its popularity boosted barnesandnoble.com sales by 59% in the third quarter, and the company says it now has 20% of the e-book market. But it projects a mere $400 million from online sales this year, compared with $31 billion for online competitor Amazon, which leads the e-reader space with the Kindle. This big differential suggests that Barnes & Noble may simply be too late to the game to be a major player.
Borders (BGP) faces all the same negative trends as Barnes & Noble. But it has a weaker brand and less-compelling e-reader offerings, so those trends are inflicting even greater pain on Borders. Sales at company stores open more than a year declined by 6.8% in the second quarter, compared with a 0.9% drop at Barnes & Noble.
This just puts Borders further along the path toward doom. While Barnes & Noble shares sell for $14, Borders' stock has fallen to just $1 and seems likely to vanish soon. The stage is set for a bankruptcy filing. "Their debt makes it impossible to survive without restructuring," says Stevens of Strata Capital Management.
The shift to online news has turned traditional newspapers into an "endangered species," says Georgetown University finance professor Angel. While high-quality papers like The Miami Herald and The Sacramento Bee may have better prospects than most, they're not immune.
So sales at McClatchy (MNI) -- which controls these two papers, among others -- fell once again in the third quarter, this time by 5.7%. Advertising revenue declined 6.4%, and circulation revenue was off 3.8%. The company did manage to get 1.6% growth in digital ad revenue. But that came through its minority stakes in Cars.com and CareerBuilder -- not the online versions of its flagship newspapers.
McClatchy has been cutting jobs to reduce costs. So it's been able to keep up with payments on its $1.7 billion in loans, a huge amount of debt for a tiny company with a market cap of just $270 million. But with revenue in steady decline, how long can this continue? At some point, cost-cutting will reduce the quality of its papers, if it hasn't already. If things get worse, McClatchy papers might survive in a buyout. But the final page will be turned in this company's history.
Long the proud king of film sales, Eastman Kodak (EK) worked hard in recent years to keep up as consumers shifted to digital photography. It's rolled out great digital cameras, digital photo printers and mall kiosks where people can print digital photos.
But it’s now facing hard times on these new battlefields against tough opponents like Apple, whose smart phones take good pictures, as well as Sony (SNE), Canon (CAJ), and Hewlett-Packard (HPQ), which sell popular digital cameras and color photo printers.
These challenges explain why Kodak sales have declined for the past two quarters. If the negative trends continue, the company could face a Kodak moment at some point in the next decade -- its final one.
Kodak responds that is has significantly improved profitability and cash flow this year, and now has $1.4 million in cash, the same as its debt. "We have a leading position in just about every market we serve, and we are quickly gaining share in markets we've recently entered," says spokesman David Lanzillo. "By any reasonable assessment Kodak is a financially sound company and a viable global competitor."
The plight of insomniacs has improved in recent years as popular sedatives went off patent to be sold in generic versions at cheaper prices. These included zolpidem, sold as Ambien, and diazepam, sold as Valium.
These drugs are typically used at bedtime. But Biotech company Transcept Pharmaceuticals (TSPT) has staked a lot of its future on a patent for a new use for zolpidem -- when insomniacs wake up in the middle of the night.
One hurdle is that the Food and Drug Administration must accept Transcept's assertion that taking zolpidem much closer to sunrise won't cause problems with activities like driving. But even if this happens, does it make sense that insomniacs and insurance companies will pay extra for a patented version of a compound they can buy in generic form?
"I don't think so," says biotech analyst Raghuram Selvaraju of Noble Financial Group. If he's right, Transcept Pharmaceuticals is in for hard times, since this re-patented zolpidem is its leading drug candidate.
Elan (ELN) is a Dublin, Ireland, pharmaceutical company dependent on two controversial drugs for survival. One is Tysabri, an effective drug already on the market to treat multiple sclerosis. But Tysabri has a history of risky side effects it can't seem to shake.
Elan's other main drug is a compound called bapineuzumab, being developed with help from Johnson & Johnson (JNJ) to treat Alzheimer's disease. This drug showed no overall benefits in cognition among Alzheimer's patients in recent studies, and it produced some side effects.
Given that the company has a lot of debt, continued problems with these two drugs could make it difficult to fund research on other drugs in the pipeline, says Morningstar analyst Karen Andersen. In this scenario, the company could sell off pieces, including successful drugs like Ampyra used to treat multiple sclerosis, and then shutter its doors and disappear, says biotech analyst Selvaraju of Noble Financial Group.
Elan responds that it has adequate financial strength, with more than $400 million in cash and projected positive cash flow for 2011 backing its $1.3 billion in debt. The company also has "one of industry’s best recognized, respected and most productive" research teams, says an Elan spokesman. "Our cash position, pipeline and capital structure give us every confidence that we will deliver for investors and patients for many years to come.”