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Market cap fluctuations reveal changing fortunes

By MARY STONE
RBJ 75
Rochester Business Journal
July 29, 2011

At the close of the second quarter of 2001, Gannett Co. Inc.'s market capitalization was $15.8 billion, giving it bragging rights among homegrown publicly held companies. Next came Paychex Inc. at $13.8 billion, followed by Eastman Kodak Co. at $11.6 billion and Xerox Corp. at $4 billion.
 
A few months later, all four companies would earn places on the BusinessWeek Global 1000, a prestigious list based on market capitalization, also referred to as market value.
 
What a difference a decade can make, however. 

Over the span of 10 years, Gannett's market value has plunged to $350 million-a drop of nearly 98 percent. Kodak has suffered a similar decline, falling 92 percent to less than $900 million. And Paychex, whose stock for years was a top performer, at the end of the first quarter this year had a market cap of $11.5 billion, down 17 percent.
 
Yet for Xerox, the story has been strikingly different: Its market value has soared more than 250 percent to $14.5 billion.
 
Over the decade, the values of some other public firms in the RBJ 75 have risen even more sharply. Graham Corp.'s market cap grew by nearly 1,595 percent; Monro Muffler Brake Inc. posted a 1,079 percent gain; and Home Properties Inc.'s capitalization rose nearly 258 percent.
 
But on an aggregate basis, these gains were far from enough to offset the reversals of fortune for Gannett, Kodak and Paychex. The total market value of the 17 companies among the RBJ 75 whose stock was publicly traded throughout the decade dropped nearly 31 percent to $33.3 billion from $48.1 billion.
 
Market capitalization, which is calculated by multiplying a company's share price by the number of shares outstanding, is not the only metric used to measure a company's value. Enterprise value-which includes debt, preferred stock and additional factors-is another benchmark. But market value generally is considered the best measure for investors to use in sizing up what a company is worth.
 
To describe the difference between enterprise value and market capitalization, Aswath Damodaran, professor in finance education at New York University's Leonard N. Stern School of Business, compared the concept to housing values.
 
"Enterprise value is the value of the operating assets of the business, whereas market capitalization is the value of the equity in that business," Damodaran said. "Think of it as the distinction between the value of the house you live in and your equity in the same house, net of the mortgage."
 
There is no significant evidence suggesting that an investor can outperform a traditional diversified strategy by looking at a yardstick like enterprise value, said Daniel Tessoni, assistant professor of accounting at Rochester Institute of Technology's E. Philip Saunders College of Business.
 
Among the public companies on the RBJ 75, industry-specific factors-not macroeconomic forces-explain the most dramatic declines in market value. Gannett, for example, is one of many newspaper publishers to struggle over the last decade. The U.S. daily newspaper industry as a whole has suffered from changing readership habits, declining circulation, shrinking advertising revenues and heavy debt loads.
 
Between 2008 and early 2010, eight major newspaper chains declared bankruptcy, several big-city papers shut down and many others laid off workers or imposed pay reductions, according to a Congressional Research Service report published late last year.
 
Gannett and other newspaper publishers are seeking to make a transition from reliance on print advertising revenue to ad revenue from the Internet, where many readers have migrated. But even after investing in the technology necessary to attract readers, only 10 percent of ad dollars industrywide was Internet-driven in 2009, according to the CRS report.
 
For Kodak, a similar effort to transition to the digital age has affected its market cap. Like many newspaper publishers, Kodak has been criticized for moving too slowly. Some critics say the photo giant was 20 years late to make the transition from film to digital.
 
By contrast, Xerox's share price has risen some 80 percent since 2001, when the company shifted its focus from hardware, where innovations were few and far between, to document management, services and support. The move brought the company back from the brink of bankruptcy to become a model turnaround story.
 
While industry shifts and companies' responsiveness to them tend to be major reasons for changes in market capitalization, broader economic factors can drag down market values too, experts say.
 
Uncertainty abounds today with the number and mix of issues affecting the stock market, Tessoni said.
 
"There is a whole confluence of factors that has created an environment that historically we haven't had to deal with," he said, pointing in particular to the federal debt ceiling showdown and the wars in Iraq and Afghanistan.
 
Another issue is future health care costs, the uncertainty of which is having a direct impact on unemployment numbers, said Jerold Zimmerman, Ronald L. Bittner professor of business administration and professor of accounting at the Simon Graduate School of Business at the University of Rochester.
 
A stock's price and market capitalization are determined by multiple factors, including the anticipated future earnings of the firm, the estimated risks it faces, the firm's liquidity and its dividend payments. All of these vary among firms and across industries, Zimmerman said.
 
Ultimately, investors are trying to predict what the firm's future cash flow is going to be by looking at the factors affecting it, such as regulations and taxes, he added.
 
"Companies are reluctant to make investments now because they don't know exactly what their health care costs are. They don't know (the effects) of all of this new government regulation that has been passed in the last two years," Zimmerman said. "It is having two effects: Companies are not investing, and at the same time the stock price of those companies is not going up as much because investors don't know what the labor costs are going to be."
 
It could take years for the regulations to be written, he noted. And without knowing the costs that will result, companies are reluctant to ramp up hiring.
 
"A lot of what you're hearing in the national media about companies not expanding and not hiring, that same argument is also affecting market capitalizations of these companies," Zimmerman said. "Investors don't know what the future cash flow streams are going to be because the companies don't know."
 
To convey the effects of uncertainty on investors, Tessoni uses the analogy of grocery shopping.
 
"Assume you went to Wegmans and there are no prices on anything. What would you do? Would you buy more or buy less? Of course you buy less," Tessoni said. "These behaviors imply that I'm going to wait until I know the outcome of these uncertainties before I make any big decisions. That is the problem we're dealing with. We're dealing with the debt ceiling; we're dealing with health care, with entitlement programs."
 
It stands to reason that investors who do not see a future growth pattern are going to lose their appetite for investment, he added.
 
"We've been in this malaise for some time," Tessoni said. Then he added: "Interestingly, the stock market has been performing reasonably well despite all of this."

7/29/11 (c) 2011 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or e-mail service@rbj.net.


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