Companies Willing to Take Risks in a Recession

Some global companies, from Fiat to Oracle to Toys 'R' Us, are taking advantage of the downturn by making gutsy moves that are likely to pay off later

By Joseph Weber

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"The time to buy," said Baron Rothschild, "is when there's blood in the streets."

These days it's hard enough for many managers to keep their businesses afloat, much less think about taking risks. After all, excessive risk-taking is what put us in the current financial mess.

Yet a few companies, big and small, are daring to go against the grain. They're scouring the bankruptcy courts for deals, getting tough with suppliers on prices, and muscling in on rivals—all to gain advantage for the eventual upswing. Fiat has successfully snapped up the bulk of assets in Chrysler, overcoming opposition. Toys 'R' Us has bought FAO Schwarz to gain market share. Procter & Gamble (PG) is investing heavily in research while others cut back. Novartis is betting its future on discoveries linked to diseases most people have never heard of.

For most executives, it just doesn't feel right to go aggressive now. But the Great Recession might be one of those rare periods when the wisest move a manager can make is to suspend his natural instincts. Imagine a driver on a snowy night. If the car starts to slip, the natural response would be to slam on the brakes and jerk the wheel in the opposite direction. But the laws of physics advise the opposite: laying off the brakes and steering into the skid.

That's not to say this is a time for recklessness. Quite the opposite: Fear focuses managers' minds better than greed, research shows. After the 2001 recession, Boston Consulting Group studied deals done from 1985 to 2000, through good times and bad. It found the average merger in a downturn created an 8.3% rise in shareholder value after two years, while the average deal in good times resulted in a 6.2% drop in the buyer's shares. The authors' conclusion: Acquirers move more carefully and squeeze out profits more aggressively when the pressure is on.

CASH HOARDS

In this unstable environment, managers need to strike the right balance between caution and boldness. Making any move now is difficult, says BCG senior partner Gerry Hansell, because "people are scared, and the bar for getting approval is pretty high." At the same time, "history is on the side of companies that buy at the bottom," says Paul Parker, head of global mergers and acquisitions at Barclays Capital (BCS). Success will come to those with "the vision to see down the road, the creativity to collect resources, and the ability to take risks," says consultant Ram Charan.

BusinessWeek set out to analyze which global players are taking the right kinds of risks. Some companies come to the endeavor easily, with cash hoards and business models geared to a slowing economy. Others are taking real chances. In the pages that follow you'll meet cautious acquirers, interlopers seeking to expand in far-off lands, long-term strategic thinkers, and entrepreneurs with big plans. Their tactics differ, but these executives share one thing: a desire not merely to survive the recession but also to thrive. P&G Chief Operating Officer Robert A. McDonald, who's slated to become CEO on July 1, calls it weiji, a Chinese term that combines crisis and opportunity. Managers can react with fear or make smart bets.

THE PRUDENT EXPLOITERS

For Valero Energy's (VLO) S. Eugene Edwards, the deal seemed tantalizing: Sixteen ethanol plants were on the block, and their owner, VeraSun Energy, was in bankruptcy court. After a brief dustup with a rival bidder, Valero walked away this spring with seven of the best plants, plus a site for another. The total cost was $477 million, a fraction of their worth. "We got first-quality plants at 30 cents on the dollar," says Edwards, who heads strategic planning at San Antonio-based Valero.

A steep drop in prices for ethanol led to VeraSun's fall. While that scared rivals, it made Edwards eager to pounce. Valero, the nation's biggest oil refiner, has a long history of snapping up distressed assets during tough times. But this is its first move into the volatile game of ethanol production. It helped that Valero had more than $1 billion in cash and that its CEO, William R. Klesse, shared his lieutenant's view that trends in Washington bode well for ethanol's long-term prospects. Federal mandates through 2022 require gasoline refineries to add increasing amounts of ethanol. Locking up a supply now may cut out middlemen and set the stage for Valero to sell ethanol to other companies.

Sunoco (SUN) is rushing into ethanol, too. On May 19 it won court approval for its $8.5 million bid for an ethanol plant from bankrupt Northeast Biofuels. A Sunoco spokesman says the upstate New York facility, the biggest ethanol operation in the Northeast, could provide 25% of the company's ethanol by 2010.

With scientists complaining loudly that corn ethanol requires more energy to produce than it yields, the recent deals are chancy. But Valero and Sunoco are betting that the Obama Administration's commitment to biofuels diminishes that risk. And both will be well positioned if corn-based ethanol gives way to ethanol variations based on prairie grass and other sources.

TROUBLE IN TOYLAND

The retail slump has put pressure on the bottom line of Toys 'R' Us. But the Wayne (N.J.) retailer has responded by going on its own shopping spree. On May 27, it acquired upscale FAO Schwarz for an undisclosed price. The deal gives Toys 'R' Us desirable locations in New York and Las Vegas and a promising Web site, says BMO Capital Markets analyst Gerrick L. Johnson, who praises the move. This is the second major purchase the 1,500-store chain has made this year. In March, Toys 'R' Us snapped up Web retailer eToys.com to gain a broader marketing reach in toys, clothes, and consumer electronics. One reason for the expansion drive is the profitability of Toys 'R' Us, which was bought by Bain Capital Partners, Kohlberg Kravis, Roberts & Co. and Vornado Realty Trust in 2005. Operating profits dipped only $75 million, to $621 million, in the year ended January 2009. That has given the retail chain a cushion, however slim, to build market share.

MERRILL DEBACLE

In many cases a company that's lurching toward bankruptcy is best avoided altogether. Bank of America (BAC) thought it was making a great deal when it agreed last year to purchase struggling Merrill Lynch. The transaction quickly torpedoed BofA's profitability and has led to a $34 billion capital gap that the bank must fill by September or face more government intervention.

But another deal struck at about the same time has turned out much differently. Last year Barclays Capital (BCS) chose to cherry-pick valuable assets from bankrupt Lehman Brothers instead of buying the whole company.

The decision is already paying off. Barclays recently jumped to No. 4 from No. 39 in the business of advising companies on mergers. The bank counseled Wal-Mart Stores (WMT) on its purchase of Chile's Distribucion y Servicio (DYS) last December, a deal that Barclays' Paul Parker, a former Lehman merger-and-acquisition executive, says neither the old Barclays nor Lehman would have landed separately. What's more, Barclays could break Lehman's record for corporate bond underwriting this year, says President Robert E. Diamond Jr. In the first quarter, Barclays was lead underwriter on 8 of the 10 biggest corporate bond offerings, including the largest agency bond ever: a $15 billion issue for Fannie Mae (FNM) in February.

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