04/22/96 LIFTOFF

LIFTOFF
Michael Armstrong has made Hughes an electronics and telecom contender
It was the morning after AT&T's Jan. 22 announcement of its $137 million investment in Hughes Electronics Corp.'s popular DirecTV satellite broadcasting service, and C. Michael Armstrong's Gulfstream sat warming up on a runway at Los Angeles International Airport. From his Olds Aurora, the Hughes chairman sprinted up the gangway and settled into his seat in the jet's wood-paneled cabin.
Within minutes, the Gulfstream thundered down the runway, then rose and banked east. Headed to New York and Boston for investor meetings and a weekend of rest at his condo in Naples, Fla., Armstrong popped open a Diet Coke and bore down on a thick roast beef sandwich. But soon the calls started pouring in. Viacom Inc.'s Sumner M. Redstone had already phoned to congratulate Armstrong on the AT&T deal. Next, Venezuelan broadcast czar Gustavo Cisneros, Hughes's partner in its Latin American DirecTV venture, relayed an equally upbeat message from Walt Disney Co.'s Mike Ovitz. By midflight, Armstrong--his blue eyes twinkling as he flashed a toothy grin--floated the notion that his biggest global rival was now Rupert Murdoch.
Hardly the typical morning of a defense-industry executive. But in the four years since the 56-year-old Armstrong left a top job at IBM to take over the struggling defense-electronics manufacturer, he has remade the $15 billion Hughes into one of the hottest consumer-electronics and communications companies around.
Indeed, the Hughes that Armstrong oversees today could hardly be further from the one he took over in early 1992. Founded by eccentric billionaire Howard Hughes in 1932 to fund his interest in aircraft research, the company spent so much money developing state-of-the-art technology that even the Pentagon balked at its high prices. Although Armstrong's predecessor, Malcolm Currie, had already cut 9,000 jobs and was pouring money into new commercial technologies, Hughes, says Armstrong, was sliding toward financial ruin. In the seven years since General Motors Corp.'s $5.2 billion 1985 purchase of Hughes, its sales had stagnated at around $11.5 billion. Earnings, meanwhile, had dropped 30% from their 1988 peak, to $559 million. With 65% of revenues coming from defense, morale was sagging, and Hughes's future was unclear.
Now, Armstrong has moved Hughes squarely into the forefront of some hugely promising--and hugely competitive--new markets. Its DirecTV satellite broadcasting system has proved one of the most successful consumer-electronics product introductions ever. Hughes's fast-growing Network Systems unit, too, is booming. It is building digital wireless and cellular-phone systems from Atlanta to Vladivostok and is now launching DirecPC, a satellite-based Internet hookup. And by 1999, Hughes's Spaceway satellite system will link phones, computers, and TVs in a seamless global network that could make cheap, easy videoconferencing a reality. Even at once mundane Delco Electronics Corp., an infusion of Hughes technology has given GM's automotive-electronics unit a jump start in developing gee-whiz features for cars.
From the beginning, Armstrong's strategy has been disarmingly simple: First, exploit Hughes's commanding expertise in satellite technology to tap into the commercial telecommunications boom. Once a product is launched, market like crazy, both in the U.S. and overseas. To finance these ventures, Armstrong has squeezed costs out of traditional military businesses.
Less visible but just as important, Armstrong has overhauled every single aspect of Hughes's operations--from the way workers get paid to the speed with which satellites are built. Striving to forge a more entrepreneurial culture, Armstrong has pounded home some simple--but for Hughes, radical--precepts. Customers count for everything. Time is of the essence. Markets are unforgiving. ``Mike has brought with him this incredible ability to focus on the customer,'' says Hughes Vice-Chairman Michael T. Smith, brother of GM CEO John F. Smith Jr. ``Without that, we would have probably been lost.''
SEEDS OF RECOVERY. And in an era when chief executives face growing criticism for overpaying themselves and pandering to shareholders by huge downsizings with little regard for job losses or future growth, Armstrong's success stands in contrast. True, for years he mercilessly slashed jobs. And he is paid amply: In 1995 alone, he earned $3.3 million in salary, bonus, and exercised options, making him GM's second-highest-paid exec, behind Smith.
But from the start, Armstrong also planted the seeds of Hughes's recovery. Even as he cut, Armstrong worked hard to rebuild morale. And over the past four years, he has invested roughly $2.5 billion in promising new markets. The result: Hughes is again hiring thousands of engineers. ``He has brought vision, cut costs, and executed a growth strategy,'' says Warren Bennis, head of the Leadership Council at the University of Southern California business school. ``He has done a terrific job.''
With the shift, Armstrong has also moved Hughes into the same universe as some of the world's most successful telecommunications and broadcast companies. Although Hughes beat Motorola Inc. for a huge cellular-phone contract from BellSouth Corp. and has outgunned Murdoch's News Corp. in the Latin American satellite-TV market, he can't afford to gloat. ``So many people have jumped into space-based communications,'' warns Norman R. Augustine, chief executive of Lockheed Martin, Hughes's biggest rival in satellite building. ``It's a lot like the airline industry 20 years ago. Traffic keeps moving up, but it's getting awfully crowded.''
Indeed, Armstrong faces a frontal assault in virtually every new market. With a new state-of-the-art satellite-manufacturing facility soon to open in California, Lockheed Martin is threatening gains in Hughes's core satellite-manufacturing business. DirecTV's success at persuading 1.5 million homeowners to pay an average of $37 a month for 175 channels of programming beamed down by satellite has spurred a small army of competitors. And despite Hughes's early gains in wireless-phone-equipment markets, its edge is quickly being eroded by giants such as Motorola and L.M. Ericsson. ``Hughes was way out in front of anybody else,'' says Evan Richards, vice-president of Ameritech Cellular Services, a Hughes customer. ``But other manufacturers have caught up.''
The trick is for Armstrong to stay one step ahead in the face of this intensifying competition. Although defense sales remain flat--and now account for just 40% of revenues--Hughes's space and telecommunications units are growing at a 19% annual clip. At the same time, tough cost-cutting sent operating margins up from 6.9% to 11.6% by 1994, though heavy spending on DirecTV knocked them down slightly last year. Sales, meanwhile, hit $14.77 billion in 1995, up 28% since 1991, while operating earnings, at $1.67 billion, have more than doubled. This year, analyst Cai Von Rumohr of Cowen & Co. expects earnings to rise an additional 8%, to $1.8 billion, on sales up 7%, to $15.7 billion.
JOINING THE INNER CIRCLE. Wall Street clearly likes what it sees. Since Armstrong's arrival, GMH shares--the General Motors stock linked to Hughes--have soared from 15 to 63. ``Armstrong is able to manage mature businesses equally well as growth businesses. That's rare in a CEO,'' says David L. King, a portfolio manager for Putnam Investment Management, which has 4% of Hughes's publicly held shares. ``If they hadn't developed DirecTV, we would not be adding to our position today.'' Indeed, after investing $750 million in DirecTV, a payoff is nigh: The service should hit the black early next year. By 1998, Rumohr expects it to add $400 million to operating profits on nearly $2 billion in revenues.
Armstrong's bosses at GM are also happy. Impressed with his early gains at Hughes Aircraft Co., they moved the poorly performing Delco under his wing in 1993. Stiff cost cuts have since nearly doubled its operating margins, too, to 15.9%. In June, 1995, Armstrong was elected to GM chief Smith's seven-member President's Council. He enjoys growing influence with Smith and his inner circle. ``It's powerful having Mike with us,'' says GM Executive Vice-President and General Counsel Harry J. Pearce, the GM board member who oversees Hughes. ``He challenges just about everything.''
GM's recent spin-off of Electronic Data Systems Corp. has fueled rumors that a similar deal for Hughes might be in the cards. Such a change would require a financial restructuring. Although 25% of GMH shares are held by the public, Hughes remains a wholly owned subsidiary of GM; the shares simply give holders a stake in Hughes's earnings. Armstrong refused to comment on the spin-off rumors, saying only that the two companies have discussed Hughes's equity structure in the past and ``continue to look at all alternatives.''
Success at Hughes is sweet vindication for the hard-charging Armstrong. The Detroit native joined IBM straight out of Miami University in Oxford, Ohio, and rose rapidly. An outgoing man known for a dogged competitiveness, Armstrong proved a forceful, natural-born salesman. Taking over IBM's troubled European unit in the mid-1980s, he became its chief pitchman. At one point he spent 45 days on the road, personally patching up relations with customers. Armstrong also slashed IBM's red tape and pushed hard into new markets in Eastern Europe. By the late 1980s, he had turned the unit around, earning Big Blue's top international job and a spot on the short list to succeed John F. Akers (page 147).
But in late 1991, Akers told Armstrong that he would not support him for IBM's top job. ``He didn't tell me why, and I didn't ask,'' says Armstrong. When Hughes called that December, he was ready to move. Although CEO Currie leaned toward a homegrown engineer as a successor, GM wanted an outsider to bring the marketing expertise it lacked.
THE NEW MANTRA. At Hughes, Armstrong found a formidable challenge. While other defense makers had repositioned themselves as defense budgets shrank, Hughes had drifted. A push to convert military technologies to commercial products was failing. And despite some streamlining, it was mostly business as usual. Senior executives enjoyed company-paid country clubs and a fleet of 16 corporate jets. High-salaried scientists at its research labs in Malibu, Calif., pursued esoteric projects with little commercial value. Although Currie had long talked about more dramatic moves, he was too steeped in Hughes's old ways. ``It takes a lot of time to change a corporate culture,'' says Currie. ``There were some things we just didn't get around to doing.''
Although impressed with Hughes technology, Armstrong was appalled by the company's business practices. ``Costs, cycle time, customer focus. Those were just not things that were part of the landscape,'' he says. Within 90 days, Armstrong ordered 30% cost cuts across the board. Before he took off on a global tour to meet Hughes customers, he gathered his managers to begin hammering home a message that would become his mantra. ``Mike said we had to focus on hitting home runs,'' says Charles F. Noski, Hughes's chief financial officer. ``If we couldn't be No.1 or 2 in a market, we shouldn't be in it.''
In all, 12,000 jobs were slashed from a workforce of 63,000 in what some still call ``the massacre of '92''; another 4,000 were cut in 1994. And the company took a $794 million write-down as it closed dozens of poorly performing units. But even as the pink slips piled up, Armstrong began rebuilding. For most of those let go, he ordered unusually generous severance: $5,000 for training or tuition, six months of health-care benefits, and up to 40 weeks of severance. That eased the pain for outgoing workers--and improved morale, winning Armstrong crucial support from those remaining. ``It was something that had to be done, but he did it well and fairly,'' says Jacques Naviaux, a manager in the Hughes radar-systems unit. ``I respected him for it.''
Armstrong also moved quickly to overhaul Hughes's culture, which featured a top-heavy hierarchy that mirrored its military clients. Managers had little accountability. And the engineers' culture rewarded those who came up with the most sophisticated inventions--whether or not the market wanted them.
So Armstrong kicked off a sweeping reform of the compensation system. All workers would earn a bonus tied to the profits their units earned. He also insisted that engineers attend finance classes. And he threw open the company's books. ``Finances were always a big secret,'' says Steven D. Dorfman, president of Hughes's satellite unit. ``Now, everyone was walking the floors talking about return on net assets.''
Armstrong also put his pitchman's skills to work, crisscrossing Hughes to spread his message. ``No matter how good your technology is,'' he told his engineers time and again, ``you cannot survive unless you grow.'' And while past CEOs were rarely seen, Armstrong began holding no-holds-barred meetings twice a month that anyone could attend. When he visited plants, he made sure to talk to workers without managers present. Insiders say he often canceled meetings with senior execs to keep talking with shop-floor workers.
A persistent, thorough manager, Armstrong is a nut for preparation. The plaque on his desk reads, ``Assume nothing.'' Armstrong always does his homework, his managers say. ``You go into a meeting, and he knows all your numbers,'' says Gareth C.C. Chang, senior vice-president of international business development. ``He has made such a commitment to you that you feel you owe him the same.''
Still, insiders say he's not a micromanager. ``Mike gets a lot done with a light hand on the reins,'' says Arthur N. Chester, Hughes research head. ``He doesn't tell you what to do; he tells you the results he wants.'' Yet woe to those who miss their targets--Armstrong also has a sharp temper. ``Mike is not tolerant of not doing what you say you're going to do,'' says Jack A. Shaw, chief executive of Hughes Network Systems.
Nowhere have the changes been more visible than in Hughes's traditional defense lines. Take the $1 billion contract for the Peace Shield, a sophisticated new air-defense system for Saudi Arabia. By 1992, the project had fallen a year behind. But Hughes was to receive a $50 million bonus if it finished construction by the end of 1995. To give the 900 engineers incentive to make up the lost ground, Hughes Aircraft President John C. Weaver proposed offering them 10% of the bonus to split among themselves. He was stunned when Armstrong offered 40% instead. When the group assembled to get the news, half listening in from Saudi Arabia, ``there was an audible hush,'' says Jeffrey D. Vermeer, a software engineer. They piled on overtime, and each earned a check averaging $22,000.
Armstrong has also brought enormous change to the once cushy Hughes Research Laboratories in Malibu. Even before he officially took the helm at Hughes, he drove up the twisting Pacific Coast Highway to brainstorm with lab chief Chester and his staff. He told the scientists it was time they started earning their keep. To improve accountability, Armstrong proposed that 50% of lab funding would come from commercial units, rather than headquarters. And imitating other well-run research labs, some 200 scientists were assigned to spend about a third of their time working for the business units.
The moves profoundly altered Hughes's scientists. ``In the past, it was detrimental to your career to get involved with the business units,'' explains Hughes scientist Adrian E. Popa. ``Now, for the first time, we sat in on top-level meetings and began tossing around marketing concepts.'' The payoff is already coming. In a wing of the lab once devoted to Star Wars research, a mix of Delco and Hughes scientists have developed an extensive array of automotive electronics.
Now making the rounds of the auto shows in a prototype vehicle known as the SSC--short for Safety, Security, Communications--many of the technologies hold commercial promise. Case in point: a collision warning system that spots cars ahead and calculates how quickly the car must stop to avoid an accident. Manufacturing engineers are trying to squeeze costs from the system so that it can be mass-produced.
Then there's a Night Vision System, which Hughes adapted from one developed for GIs in the Persian Gulf War. It features an infrared camera that can ``see'' three times farther ahead than a driver with standard headlights. The image of, say, a nighttime jogger, can be projected onto the windshield, another technology borrowed from jet fighters. But this one also gives drivers navigational information, collision warnings, and other information.
Will this technology ever find its way into ordinary cars? Some of it already has. This fall, buyers of 1997 Cadillacs will be offered an optional $1,000 service, called OnStar, developed by Delco. OnStar will link into Cadillac customer service, which will know where a car is. It can give directions, unlock the door when a driver locks the keys inside, and automatically call for help when the air bags deploy. Toyota Motor Corp. hopes to add Delco's radar collision warning system to its cars within five years.
DISPROVING THE SKEPTICS. But it is the high-profile satellite business that Armstrong has really trained his sights on. Although Hughes had been an early satellite pioneer, by the early 1990s, it was custom-building just three birds a year, and worldwide market share had fallen to just 40%. To speed production, Hughes ended customization and centralized manufacturing from 43 locations into one factory floor. Employees were invited to fill out weekly ``yellow sheets'' with ideas for improving production techniques. With ideas flowing in, production has soared to 15 satellites a year, and Hughes today holds 60% of the $5 billion market for commercial satellites.
That turnaround was key to Armstrong's strategy of pushing rapidly into related satellite services. Most dramatic has been the highly successful launch of DirecTV. Although it was in the works before Armstrong arrived, he gave the project high priority and calmed GM's board when it worried that its $750 million investment wouldn't pay off.
Disproving skeptics, the service has been a smash hit--and President Eddy W. Hartenstein projects it will have 10 million viewers by 2000. That heady lead persuaded AT&T to give up plans to launch its own competing service in late 1995. ``We wanted to be in this industry fast, and we wanted to be in big,'' says Joseph P. Nacchio, who heads AT&T's consumer unit. ``That meant DirecTV.''
The U.S. moves are just the first stage of Armstrong's plans. In May, Hughes will roll out DirecTV in Latin America. Next comes Japan in 1997, followed by a launch in Europe or China. Says Armstrong: ``The potential for international business far outstrips anything we can do just in the U.S.'' Back in America, rival satellite-TV services such as Primestar and Echostar Communications Corp., which is launching services on May 1, are targeting Hughes's turf. A far bigger threat comes from Murdoch's News Corp., which is also launching a Latin American satellite service by July. And Murdoch, who has teamed up with MCI Communications Corp. in a $2 billion joint venture, may also soon link with cable powerhouse Tele-Communications Inc. Such a combination would give Murdoch worldwide reach and extensive programming. ``Murdoch would all of a sudden have global programming,'' says Rick Westerman, an analyst with UBS Securities. ``That could really crimp DirecTV's strategy.''
Indeed, Westerman warns that Hughes could face tough margin pressure as competition sends hardware prices and subscription fees tumbling. That will make it harder for Armstrong to secure the earnings boost from DirecTV he's counting on. He has to keep up a heavy spending program--though his other high-tech bets are far from sure. Hughes's DirecPC satellite Internet link will face stiff competition from high-speed cable modems, while its Spaceway satellite videoconferencing system still must clear regulatory hurdles. But Armstrong is not worried about rivals. ``I think the combination of GM, AT&T, and Hughes is at least equal to that,'' he says. ``There's plenty of room for growth in these markets.''
Armstrong also has to keep up the pressure at $1 billion Hughes Network Systems, which supplies wireless phone equipment and infrastructure. He has helped HNS push a line of small satellite ground stations--known as VSATs--to provide telephone service to remote areas of the developing world. Sales are growing at 20% annually. Armstrong has also helped HNS land deals to provide fixed wireless phone service to countries such as the Czech Republic and Vietnam, a business that has grown from nothing to $200 million since 1994.
Pursuing those and other international markets is what Armstrong--who spends more than half of his time on the road--is pushing hardest these days. Last October, he and international head Chang flew to Beijing. In a quiet meeting with Chinese President Jiang Zemin, the two laid the framework for bringing DirecTV to China. Armstrong also used his entree to help win a $640 million bid to supply China with satellites and handsets, beating out Loral Corp. and Lockheed Martin. ``He stepped up what would have been a two-year dialogue at lower levels,'' says Chang. ``He clearly showed the Chinese what was in it for them.'' With results like that, Armstrong is likely to be spending a lot more time in his Gulfstream munching down cold roast beef sandwiches.
By Eric Schine, with Larry Armstrong, in Los Angeles, Kathleen Kerwin in Detroit, and bureau reports