Risk Analysis of Primark
At the time, American Natural Resources was operating two primary subsidiaries: Michigan Consolidated Gas, which was a distributor of natural gas serving the Detroit area, and a sister company that operated an interstate gas pipeline. Although the two companies seemed to complement each other, regulatory constraints were stifling potential synergies. The gas pipeline company, which was regulated at the federal level, was highly profitable. In contrast, Michigan Consolidated had long suffered from tepid earnings and thin rate increases.
The main problem was that Michigan regulators had been unsympathetic to rate hike requests because American Natural Resources generated so much profit from its gas distribution company. Frustrated with the situation, American Natural Resources decided to jettison its lagging Michigan Consolidated Gas subsidiary in 1981. The new enterprise formed
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Under his direction, Michigan Consolidated thrived. Its early success was primarily the result of rate hikes; Michigan regulators were forced to give Michigan Consolidated rate increases that would allow the company to survive on its own. Although the company continued to churn out sales of about $1. 1 billion annually, its profits began to rise. By 1984, in fact, Michigan Consolidated was approaching the maximum return on equity allowed by state regulators. Stewart recognized early that Michigan Consolidated’s prospects for growth were limited.
So he formed the holding company Primark as part of his long-term diversification strategy. He planned to use excess cash from Michigan Consolidated to fund acquisitions of non-gas companies that would boost Primark’s overall profits. To that end, Stewart and his fellow executives engineered the buyout of several companies in different industries during the early 1980s. They purchased a small California thrift, for example, and a couple of small insurance companies.
Among their most notable buyouts was Hospital Satellite Network, a satellite broadcasting service for hospitals that arranged teleconferences and provided medical training programs. Primark bought that start-up company in 1983 with the intention of using its deep pockets to fund its rapid growth. Although management of those diversified holdings by a gas company seemed like a stretch to some observers, Stewart cited the very strong numbers orientation of his management team. Furthermore, Primark was selective about its acquisitions.
In 1984, for instance, the company considered but rejected a proposal to buy Continental Health Care Systems, a producer of mini-computers for hospitals. The end result of Stewart’s overall strategy was that sales and profits rose, and Primark’s stock price increased sharply between 1981 and 1985. Encouraged by gains, Stewart pursued more acquisitions, beginning with the 1985 buyout of The Aviation Group, a company that provided pilots and maintenance personnel to package air carriers like United Parcel Service, Emery Air Freight, and Purolator Courier.
Other major buys included Telerent, which leased televisions, receivers, and satellite equipment to the hotel industry. By 1987 Primark’s portfolio of holdings consisted of Michigan Consolidated, an aviation group that provided cargo aircraft operations and maintenance services, Hospital Satellite Network, and a financial division with leasing, mortgage, and insurance operations. Unfortunately, Stewart’s diversification plan began to sour. During the first nine months of 1987, in fact, only Michigan Consolidated and the financial division were profitable.
Among other setbacks, The Aviation Group lost its major customer, UPS, which accounted for about 50 percent of that subsidiary’s sales. That blow resulted in a $64. 4 million restructuring charge related to the division late in 1987. And, while Hospital Satellite Network had a lot of potential, the venture was still in the early stages of growth and was consuming relatively large amounts of capital for expansion. Primark managed to capture about $1. 6 billion in revenues and $51. 7 million in net income during 1986.
But profits began to slip in 1987 and the company’s stock price plunged–the stock dip was also the result of the 1987 stock market crash. Critics charged that Primark’s diversification strategy lacked direction, and that the company was failing to realize any benefits from investing excess cash from Michigan Consolidated in its acquisitions. Even Stewart conceded that his plan was not working as he had hoped it would. Stewart had planned for non-gas acquisitions to eventually represent about one-third of the company’s profit. By mid-1987, however, they were making up less than ten percent.