01 Sept 2023 Articles

Competition Analysis in Finance (Part 2)

10 minute read


Economist Daniel Urdaneta recently authored a two papers in a short series for Chartered Financial Analyst (CFA) Institute, Chile. In the second of these papers on integrating competition economics concepts into the investment process, Daniel reviews case studies of companies that lost market power and posted heavy losses in the last decade. He also points out the warning signs to determine if a company is at risk of losing its competitive moat.

For some, competition is a losing game

Competition in a contemporary market economy considers a multitude of strategic decisions by firms (e.g., levels of CAPEX and R&D, M&A activity, entry/exit to certain markets or product lines, etc.). The combination of decisions of each firm with respect to its competitors, as well as exogenous factors (such as innovation shocks) lead to a constant process of "creative destruction", with winners and losers within each industry.

The first column, in the June Newsletter, focused on the "winners" - companies with total returns in excess of 1,000% over the last decade, highlighting companies such as Microsoft, Apple, NVIDIA and Tesla that were winners in this process of creative destruction. This column will focus on the "losers" - the companies that were unable to adapt to the wave of innovation in their industries.

Risk signs of a "losing" company

The key element in determining whether or not a company is at risk of becoming a "loser" lies in analyzing the strength of its competitive moat. There are several signs of a fragile moat:

(Lack of) control over data: If a company is not able to somehow monetize the data it receives from its users (or if it cedes control of this data to a larger platform - privacy policy tying) [8], it would hardly be able to compete effectively with data-rich incumbents on any meaningful dimension. This is a very recent risk factor, relevant in industries with platform characteristics (e.g., social networks, marketplaces, search portals, etc.), characterized by markets concentrated in one or a few players (with low interoperability among them) in equilibrium.[9]

Case studies

Let’s now go over a brief summary of 7 case studies of "loser" companies in the US over the last decade. This list is comprised of companies that were at one time part of the S&P 500 index (or very close to inclusion) and posted total returns of -66% or worse between August 2013 and August 202 [10][11], and the economic fundamentals behind their poor performance. These companies provide very clear examples of companies that were unable to reinvent themselves in the face of innovation and changing competitive dynamics in their respective industries.

1. Bed, Bath & Beyond (OTCMKTS:BBBYQ)

Total return (August 2013-August 2023): -99,6%

Bed, Bath & Beyond never specialized in a specific niche market - its stores sold "home varieties" chosen by the local management of each branch - and was unable to counterbalance the fierce e-commerce competition in its segment (Amazon, Wayfair, Target, Walmart, etc).

One of its last attempts to remain viable was to exercise its market power as a platform - by replacing third-party products with higher-margin private label goods- which proved disastrous, as the attempt to integrate upstream activities coincided with the crisis in supply chains due to the COVID-19 pandemic. The company finally filed for bankruptcy in April 2023.[12]

2. Groupon, Inc. (NASDAQ:GRPN)

Total return (June 2013-June 2023): -96,1%

Groupon went from being one of the most valued tech startups in the past decade - garnering a valuation of USD 17.8 billion at its IPO in 2011 - to a company on the verge of bankruptcy in 2023.[13] In 2010, Groupon resisted Google's acquisition attempts (for USD 6 billion) and a year later went public - [14] perhaps not the best decision in hindsight.

Groupon's negative performance is mostly driven by the fact that its business model - a platform that connects merchants with potential customers through "exclusive" promotional discounts – inherently lacks a competitive moat. Indeed, in the last decade, multiple companies have iterated on the retail digital platform concept - including both major retail chains and new platforms with specialized segments (Uber, Booking, Expedia, Airbnb). On the other hand, discount platforms such as Groupon’s fostered very bad agency issues on the s supply side (e.g., misleading offers; sustained quality decreases; service problems due to congestion; self-selection towards the lowest quality providers; etc.). The straw that broke the camel's back was that, in 2013, Google implemented changes to Gmail functionality that substantially limited the reach of Groupon's email chains (its main historical marketing channel).[15] Groupon was never able to integrate downstream distribution channels in a meaningful way, so it lost the attention of their consumers very quickly after the Gmail’s “shadow ban”.

3. Lumen, Inc. (NYSE:LUMN)

Total return (June 2013-June 2023): -89,0%

Lumen (formerly CenturyLink) is one of the world's largest companies in wholesale internet infrastructure (e.g., submarine fiber optic cables and long-haul transmission networks). The company has been in a negative trend since the Great Recession (the stock reached an all-time high price in July 2007 and is down ~98% since then), and its rate of decline has accelerated substantially over the past five years.

The analyst consensus is that the company lacks market power, as it is subject to an "intensely competitive Internet market, increasingly standardized and characterized by high fixed costs and low variable costs", and that its negative performance will continue through the vicious circle of falling gross margins, rising debt, forced sales of strategic assets to pay off debts, further fall in margins, etc.[16]

4. Dish Network (NASDAQ:DISH)

Total return (June 2013-June 2023): -81,6%

Like Lumen, Dish is another company in the telecommunications industry that lost out in the most recent wave of innovation. Dish's problems can be summarized in a "double whammy". On the one hand, the traditional business (satellite TV and Internet TV) is in decline – Dish has experienced annual churn rates above 10% in recent years – and increasing competitive pressure from streaming alternatives.[17] On the other hand, the future growth area (5G mobile services) has represented an unprecedented multi-billion dollar investment in spectrum, radio stations and connectivity technology in the US, but its deployment began much later than the 5G networks of the incumbents (AT&T, Verizon, T-Mobile) and has only started activities in June 2023, [18] in a market with fierce downstream competition and increasingly narrower margins. Dish is also in a debt vicious cycle of debt like Lumen, and may be forced to sell strategic assets in the near future – including their spectrum licenses– to stay alive.

5. Teva Pharmaceutical Industries Ltd (TLV:TEVA)

Total return (June 2013-June 2023): -72,2%

Since its inception, Israel's Teva - one of the world's leading generic drug producers - does not command a moat for proprietary rights as, except for a multiple sclerosis drug - Copaxone - it mostly specializes in generic drugs. After a history of failed acquisitions (most notably the USD 40.5 billion purchase of Actavis from Allergan in 2015) and strategic mistakes by the company, Teva has been facing high debt loads, margin erosion (due to increased competition in the generics market) and increased market power on the demand side (due to partnerships between healthcare providers and insurers in the US).[19]

Teva also has other challenges: an antitrust lawsuit in the US for collusion in the generic drug market [20] and lawsuits in the European Union [21] and the US [22] linked to "pay for Delay" practices (i.e., out-of-court settlements with potential entrants to delay the launch of generic versions of Copaxone and HIV drugs to the EU and US markets, respectively).

6. Warner Bros. Discovery, Inc. (NASDAQ:WBD)

Total return (June 2013-June 2023): -67,7%

Discovery Inc. became Warner Bros Discovery in 2022, following the merger of two of the world's leading producers of pay TV, film and streaming content. The company nominally commands a moat based on its portfolio of iconic IPs in movies and series. However, WBD has been facing increasing competitive pressure on the streaming side (where other players such as Netflix, Disney, Amazon and Apple compete with larger budgets than WBD, and without cannibalization problems in its core business) and continues to be affected by cord-cutting in traditional TV, which to date remains its main line of business.[23]

7. Sabre Corporation (NASDAQ:SABR)

Total return (June 2013-June 2023): -66,3%

Sabre specializes in providing IT services for select industries. Its main product is a platform that connects airlines with travel agencies, allowing agencies to access "preferential" airline ticket prices that are generally not available through other sales channels. This business model was hit hard by the COVID-19 pandemic (due to the decline in the flow of tourists globally, which has not yet recovered), but also by increasing competitive pressure from online rivals (e.g., Booking, Expedia, Despegar), and the airlines' own direct sales channels.

Last year it suffered a setback when it was found guilty of antitrust violations in the U.S. (for applying an exclusive distribution model that increased airfare prices for end customers).[24] It is difficult for Sabre to sustain itself in the long term in the airline ticket market, as it is no longer a gatekeeper for end consumers.

Read the full paper here

This paper was originally published for the Chartered Financial Analyst here. The views expressed are those of the authors only and do not necessarily represent the views of Compass Lexecon, its management, its subsidiaries, its affiliates, its employees, or client.

[1] This is seen in the pharmaceutical industry, with high levels of generic drug competition. See Grabowski, Henry G., and John M. Vernon. "Brand loyalty, entry, and price competition in pharmaceuticals after the 1984 Drug Act." The journal of law and economics 35.2 (1992): 331-350, available at: https://dukespace.lib.duke.edu/dspace/bitstream/handle/10161/2611/Grabowski1984DrugAct.pdf.

[2] An example in Chile is the e-commerce logistics market, with a high level of competitive rivalry and low profitability. See: https://www.df.cl/empresas/retail/una-burbuja-logistica-crece-la-feroz-competencia-en-la-industria-de.

[3] This factor is observed in industries with a high level of innovation, such as information services and telecommunications. An illustrative example comes from streaming video-on-demand (SVOD) platforms displacing traditional pay TV amid a fierce competitive environment; see: https://seekingalpha.com/article/4360957-streaming-wars-tale-of-creative-destruction.

[4] An example is seen in the US oil industry. More than 60 small-scale producers filed for bankruptcy in 2020 due to the drop in oil prices at the onset of the COVID-19 pandemic. See: https://www.reuters.com/article/us-global-oil-usa-restructuring-focus-idUSKCN2250FQ.

[5] This factor is seen in industries such as retail, media entertainment, sports and digital platforms, as well as some manufacturing industries. Bidders with low bargaining power are exposed to abuses by gatekeepers (i.e., intermediaries between bidders and final consumers with market power) or providers of essential inputs. See: Grimes, Warren S. "Buyer power and retail gatekeeper power: protecting competition and the atomistic seller." Antitrust LJ 72 (2004): 563, available at: https://heinonline.org/HOL/LandingPage?handle=hein.journals/antil72&div=24&id=&page=.

[6] See New York Times, “ Was This $100 Billion Deal the Worst Merger Ever?” (28 Nov 2022) on: https://www.nytimes.com/2022/11/19/business/media/att-time-warner-deal.html.

[7] This conclusion comes from the specialized literature. In this regard, see Kedia, Simi, S. Abraham Ravid, and Vicente Pons. "When do vertical mergers create value?" Financial Management 40.4 (2011): 845-877, available at: http://bit.ly/3YuPkfJ.

[8] In this regard, see Condorelli, Daniele, and Jorge Padilla. "Data-driven envelopment with privacy-policy tying." Available at SSRN 3600725 (2020), available at: https://www.condorelli.science/PEPPT.pdf.

[9] In this regard, see Dubé, Jean-Pierre H., Günter J. Hitsch, and Pradeep K. Chintagunta. "Tipping and concentration in markets with indirect network effects." Marketing Science 29.2 (2010): 216-249, available at: https://www.jp-dube.com/research/papers/216full.pdf.

[10] Capital appreciation + dividends, considering dividend reinvestment. Estimate based on DQYDJ available at: https://dqydj.com/stock-return-calculator/. Updated: August 7, 2023.

[11] Several related cases fulfilling the conditions (Silicon Valley Bank, First Republic Bank and Signature Bank New York) were excluded because their decline was due to financial risk management failures rather than pure loss of competitiveness.

[12] See: https://www.npr.org/2023/04/24/1152070914/bed-bath-the-great-beyond-how-the-home-goods-giant-went-bankrupt.

[13] See: https://thehustle.co/whatever-happened-to-groupon/.

[14] Sources consulted by the press at the time state that Google desisted from acquiring Groupon due to risks of antitrust intervention. See: https://www.businessinsider.com/why-groupon-said-no-to-google-2010-12.

[15] This risk factor was first raised in 2013 by Groupon's board. See: https://www.digitalcommerce360.com/2013/11/14/groupon-hit-hard-gmails-changes-rethinks-e-mail/.

[16] See: https://www.marketwatch.com/story/lumen-stock-plunges-toward-levels-not-seen-in-34-years-amid-a-reset-11675872346.

[17] See: https://www.lightreading.com/videomedia/dishs-satellite-tv-biz-isnt-going-away-ergen-says-/d/d-id/784780.

[18] See: https://www.fiercewireless.com/5g/dish-5g-network-now-available-over-70-us-population.

[19] See: https://www.nytimes.com/2017/12/27/business/teva-israel-layoffs.html.

[20] See: https://www.justice.gov/opa/pr/seventh-generic-drug-manufacturer-charged-ongoing-criminal-antitrust-investigation.

[21] See: https://ec.europa.eu/commission/presscorner/detail/en/IP_22_6062.

[22] See: https://www.fiercepharma.com/pharma/gilead-tevas-hiv-antitrust-trial-kicks-california.

[23] See: https://www.fool.com/investing/2023/03/31/warner-bros-discovery-is-down-40-since-its-debut-t/.

[24] See: https://www.reuters.com/business/aerospace-defense/american-airlines-gets-favorable-antitrust-verdict-1-damages-2022-05-19/.

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