Given stock markets’ unprecedented performance during the pandemic years of 2020 and 2021, 2022 should have been even better with recovery from the pandemic and reopening of businesses. But the stock market performance has been exactly the opposite. A few firms losing 60% or more of their value is not an unusual thing — it happens regularly. And it can happen en masse like during the dotcom bust in 2000. What’s unusual about today’s situation is that some of the current orphan stocks — those that have lost more than 90% of their recent stock price peaks — remain market leaders and their products continue to have mass appeal. For example, most of us continue to buy products and services from Netflix, Uber, Gap, Zoom, and Roku. In addition to the challenges of managing day-to-day business operations, managers must take aggressive but thoughtful action to bring back shareholder confidence. The authors recommend several steps to achieve that goal.
Numerous well-known companies have seen a decline of 60% or more in their stock prices from their recent peaks, all within a span of one year. They include Netflix, the streaming service; PayPal, the online payment company; Moderna, the Covid-19 vaccine maker; Roku, the digital media player; Peloton, the internet-connected stationary bicycle maker; Uber and Lyft, the rideshare companies; Gap, the apparel seller; Zoom, the video communication company; and DoorDash, the online food delivery platform. Some, like Peloton, have lost more than 90% of their recent stock price peaks, a category we call orphan stocks. Strangely, none of these companies are going out of business soon. On the contrary, their products remain in demand, and they retain leadership positions in their fields. So, what has changed, and what can managers of these companies do to bring back shareholder confidence?
The pandemic unquestionably dictated the dynamics of stock markets in the last two years. It all started with heightened uncertainty in the business environment after formal declaration of the pandemic by the WHO. Most stock market indices declined precipitously from February 2020 to mid-March 2020. To deal with the panic, governments and central banks around the world responded with unprecedented fiscal and monetary policy, including interest rate cuts and infusion of liquidity in the market. Flushed with liquidity, and with fewer avenues to spend discretionary funds due to closures of shopping, travel, and tourism, households piled money into equity markets. This led not only to a reversal in stock markets, but a surpassing of all previous peaks. The Dow Jones Industrial Average approximately doubled from mid-March 2020 to the end of 2021. The tech-heavy Nasdaq Index increased by more than 150% from mid-March 2020 to mid-November 2021. The euphoria attracted many new investors and companies to the stock market. There was a wave of initial public offerings (IPOs) and raising of capital through special purpose acquisition companies (SPACs). The number of IPOs during 2020 and 2021 totaled more than previous five years combined.
Given stock markets’ unprecedented performance during the pandemic years of 2020 and 2021, 2022 should have been even better with recovery from the pandemic and reopening of businesses. But the stock market performance has been exactly the opposite. Nasdaq has dramatically declined from its November 2021 peak. The magnitude of this drop can be judged from the fact that latest drop in index of 5,250 (from November 19, 2022 to June 17, 2022) is more than 1.5 times the drop seen during the early days of the pandemic (about 2,850 from February 19, 2021 to March 8, 2021). This 2022 decline in stock prices can be attributed to the Fed’s reversal of easy-money policies, the Russia-Ukraine war, ongoing supply chain disruptions, China’s zero-Covid policy, oil price increases, raging inflation, and a fear of recession.
What’s Different This Time?
A few firms losing 60% or more of their value is not an unusual thing — it happens regularly. And it can happen en masse like during the dotcom bust in 2000. What’s unusual about today’s situation is that some of the current orphan stocks remain market leaders and their products continue to have mass appeal. For example, most of us continue to buy products and services from Netflix, Uber, Gap, Zoom, and Roku.
It will be useful to divide these stocks into two types. The first are those that benefited from the unprecedented conditions of the pandemic and that are now seeing the reversal of those conditions. These include Zoom (offices are opening again and travel is resuming), Netflix (people are spending less time binge-watching), and Moderna (its main revenue source remains Covid-19 vaccines). The second are those that have been affected by the ongoing supply chain issues, rises in input prices, and labor shortages. For example, while the demand for clothes increased after the pandemic, Gap has been unable to meet customer demand with the right kind of inventory because of supply chain issues. Similarly, while many people have resumed eating in restaurants, Denny’s, a diner-style restaurant chain, is suffering from labor shortages and increases in food prices.
In the spirit of Leo Tolstoy’s claim that all happy families are alike, but every unhappy family is unhappy in its own way, the pandemic started with similar market forces for companies’ stocks, but those stocks turned into orphans in their own ways. The forces underlying each market drop can be seen as either price corrections from previous values that are unjustified under a pandemic-controlled environment or reflective of more fundamental issues. Some may disregard this decline and think that stock markets are a sideshow. But good managers understand that stock price decline can affect real business. Talent, the most precious commodity today, is paid in part via stock and stock options. A firm’s ability to raise capital to fund its growth is linked to its stock prices. And firms often grow with acquisitions, using their own stock as a currency to acquire other companies.
How to Bring Back Shareholder Confidence
In addition to the challenges of managing day-to-day business operations, the current situation requires an aggressive but thoughtful set of actions from managers — and all of this must be done while dealing with the effects of inflation and recession. Managers must first distinguish between temporary and fundamental problems affecting their stock price. For example, supply chain issues, especially form China’s zero-Covid policy, can be expected to normalize more quickly than those stemming from the Russia-Ukraine war. Recession concerns should cease in a year or so, as the underlying productivity and unemployment remain strong. However, people are unlikely to revert to spending as many hours exercising on their Pelotons or binge-watching movies on Netflix as they did during the pandemic. Managers must understand these factors and then attempt to bring back shareholder confidence. We recommend the following steps to achieve those goals.
Improve Communication with Investors
New investors, especially those new ones who bought during recent peaks, must have several unanswered questions and potentially different views about the future direction of companies. Many of their concerns are legitimate, and management needs to address them — silence only exacerbates investors’ fears about worst-case scenarios. Additionally, after such steep price declines, firms usually also experience a decline in equity analyst coverage. A lack of institutional research reduces firm visibility and investor understanding of firm operations, further tarnishing investor confidence. Thus, increased communication and transparency can help alleviate some of those concerns and build credibility with investors. Managers can bring more visibility to the company by hiring social media influencers and public relations firms that target investing communities. Managers must also frequently participate in analyst- and investor-arranged conference calls and openly discuss current challenges and their plans to address them. These steps can help increase stock liquidity, improve valuations, and counteract the decline in the number of analysts following the company.
Refocus Corporate Strategy
The macro environment, the availability of capital, and investor expectations were very different during the last two years than they were before. Loss-making firms showing extreme growth could command lofty valuations and easy rounds of funding. While conventional wisdom advises that a company shouldn’t change its strategy according to changing stock prices, the harsh reality cannot be ignored. Perhaps the stock market is right, and “growth-at-all-costs” isn’t the best strategy, at least for some orphan stocks in the current environment.
Instead, companies should prioritize segments and business lines that are performing the best in order to bring revenues and profits more quickly and subsequently regain investor confidence. Peloton, for example, will focus on branding and marketing and exit manufacturing. Experiments with uncertain payoffs can wait. A rising rate environment with massive inflation means that long-duration assets — those that will potentially deliver cash flows several years from now — get low valuations today. Therefore, firms should focus on improving the fundamentals first to boost investors’ confidence and survive in this tough environment. Once managers have regained investor confidence with good execution and investors understand management’s capabilities, firms can think about shifting their focus to growth.
Nevertheless, firms must keep looking for new revenue sources that can accrue with little investment. For example, Netflix is planning to introduce cheaper, ad-supported services and start charging for password sharing.
Signal Confidence to Stabilize Price
Managers send signals to the market about their confidence and optimism about the future through financial transactions. For example, announcements of secondary rounds of equity offering indicates that the stock is overvalued. Announcements of buybacks, in contrast, indicate that the stock is undervalued. Managers can thus announce stock buybacks to signal that they think that their stock is cheap.
Senior managers’ compensation comes primarily from stocks and stock options. Hence, managers tend to hold large numbers of shares and stock options in their company. Investors closely watch managers’ insider transactions. Managers’ sale of stock holdings signals their pessimism about the future of the company. If managers indeed need to sell to meet their funds requirements, they must preannounce their intentions to sell a predetermined amount of stock holdings on a predetermined date, to avoid giving the impression that they’re selling in anticipation of bad news.
Tough times that lead to huge declines in valuations can create uncertainty among employees and affect their morale. Because option values decline faster in percentage terms than stock prices, employees’ stock options become worthless. As employees look elsewhere for fresh compensation packages, firms can easily lose valuable talent. If top employees start leaving the firm, then that will further lower shareholder confidence. Therefore, managers must focus their efforts on retention and enhancing worker confidence in the company — for example, by regularly communicating with employees, implementing more flexible policies like work from home, issuing fresh grants of stock options to employees, or repricing their existing options to lower the strike price to current levels.
In the past few months, some companies, including giants like Tesla, Microsoft, Apple, and Google, have switched from hiring aggressively to hiring freezes. In some cases, they’ve even rescinded offers and laid off employees because of a change in the economic environment. As other companies cut their technology investments and implement across-the-board cuts, it gives competitors a better chance to acquire them than during the euphoric markets. For example, numerous tech workers are now looking for jobs, unlike just six months ago, when it was very difficult to hire top tech talent. Similarly, the collapse of the crypto market means that Fintech companies can now hire the talent they desperately needed but that was previously headed to crypto companies. Companies can announce the hiring of a star scientist or brand manager to signal to their investors that they’re a part of a healthy business, not a sinking ship.
Merge with Other Orphan Stocks
Firms competing in similar markets, using the same resources, and having economies of scale and scope might create value by merging together, as long as there are no anti-competitive pressures. Think of Uber and Lyft and Uber Eats and DoorDash. In the first case, both competitors address the same markets and customers and use the same set of contractor drivers. In the second case, both competitors rely on the same set of restaurants, deliver food to the same homes in the same neighborhoods, and rely on the same set of delivery agents. It leads not only to two costly systems addressing the same markets, but also to price undercutting and discounts to capture each other’s market shares. As both sets of companies become orphan stocks and continue to incur large losses, it might be in both parties’ interest to merge and consolidate their operations. They at least might be able to reverse their discounts for a healthier cash flows.
Delay Secondary Equity Offerings
In this environment, any fresh round of equity offering in public markets is perceived negatively by investors. Firms are better off borrowing money, or using internal funds, than issuing further shares to the public markets. Stated differently, firms must consider borrowing instead of equity issuance as a funding source until their share prices recover. If they have no other choice than to issue additional equity, firms must approach strategic investors, private equity investors, or venture capitalists. Those investors, unlike common investors, better understand the firm’s business and can better appreciate their long-term prospects than public investors in these times.
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A volatile macro-environment presents a nightmarish scenario for managers of firms with established business models that remain market leaders but whose shares have turned into orphan stocks. But all is not lost — by taking steps to restore shareholder confidence, managers can help their companies survive and even emerge stronger.