Friday, March 28, 2014

It’s the Quality of Disclosure, Stupid

When Bill Clinton was running for president for the first time, one of the catch phrases of his campaign was, “It’s the economy, stupid”.  One of the things meant by this (with Bill Clinton, you’re never sure if you’ve captured all of the intended meanings) was that people should focus on the main issue and stop talking about the many smaller peripheral issues that can distract voters from what is important. That’s the way I feel about many earnings press releases I read.
Take, for example, Walgreens recently released second quarter 2014 earnings. Readers of this blog will know that I often write about Walgreens, but when you write, its best to write about something you know, and having worked at Walgreens, I think I know it better than the average investor (I also own the stock). There are a lot of things going on in the second quarter earnings release, and to a certain extent, Walgreens finds itself boxed in by all the adjusted earnings they’ve reported in the past. Having elected to report “adjusted earnings” (see my post from June 26, 2013 “The Slippery Slope of Adjusted Earnings” http://investorrelationsmusings.blogspot.com/2013_06_01_archive.html ) Walgreens now finds itself in the uncomfortable position of reporting that what they consider core earnings reflecting the true underlying nature of the business are 5% lower than they were a year ago. This compares to earnings only being down 1% on a GAAP basis. I give them full credit for continuing to report this way, as many companies would have stopped reporting on an adjusted basis the moment it didn’t serve their purpose, but it just goes to show how you can get boxed in by these adjustment shenanigans. 
However, what really caught my eye in the earnings release was a claim of combined synergies for Walgreen and its strategic partner, Alliance Boots, of approximately $236 million in the first half of fiscal year 2014.  When I see a claim for such a big number, a red flag always goes up in my mind and I start looking for where all this money has filtered into the earnings statement. After all, if you are claiming a synergy, you either have to be buying better and thus reducing your cost of goods, or lowering your expenses, reducing your selling, general and administrative expense. Synergies of $236 million on a base of $37.9 billion should result in savings of .62% in these ratios for the first half of the fiscal year. Yet when I compare the cost of goods and S, G & A ratios from year end 2013 to 2Q2014, I find that cost of goods have actually gone up 10 basis points, so they’re not buying better as a result of the acquisition. The S, G & A ratio on the other hand, has declined 60 basis points to 23.3% from 23.9%. So maybe they are within shouting distance, 8 basis points, but then I have to ask, “Does this synergy number mean that your earnings would have been worse by $236 million if you had not done the acquisition?” I suspect not, and I think you would very quickly get an answer from the company that the calculation of synergies does not tie directly to earnings.
Unstated in all of this is that “synergies” is a non-GAAP term, not constrained by the bounds of normal accounting. Companies can and do throw all sorts of “opportunity costs” and hypothetical savings into the pot when calculating these sorts of things. It is sort of an alternative accounting universe that does not have to tie out to the earnings statement. (I’ve also written about this before, see my post of March 3, 2012, “Where’s the Beef?” http://investorrelationsmusings.blogspot.com/2012/03/wheres-beef.html )

Which brings me full circle. These types of claims detract from and make it look as if the company is trying to obscure what is really going on - “Look at the great synergies we’re getting, not at the fact that earnings are down”. So my advice to companies that engage in this sort of junky accounting is: “It’s the quality of disclosure, stupid.” 

Monday, March 3, 2014

The Intersection of Law and Financial Theory

When lawyers and judges venture into the realm of financial theory, interesting things happen, often accompanied by unintended consequences. Take, for example the efficient market hypothesis. As anyone with a grounding in financial theory knows, the efficient market hypothesis (in the semi-strong version) holds that the market quickly incorporates all readily available information into stock prices. In 1988 the United States Supreme Court used this theory to create the legal doctrine of “fraud on the market”, which holds that shareholders do not have to directly prove that there is a connection between a shareholder’s losses and the fraud being alleged. Rather, the courts assume that the shareholders have been harmed by an alleged fraud because the market has incorporated the fraudulent information into the stock price, regardless of whether the aggrieved shareholder can show direct reliance on the fraudulent information.

The upshot (and unintended consequence) of this legal doctrine was a surge in the number of securities class actions filed beginning in 1988. In fact, it became so bad that Congress stepped into the fray and enacted the Private Securities Litigation Reform Act of 1995. This act made things tougher on plaintiffs, requiring them to plead the alleged securities fraud with a great deal more specificity than before and creating a “safe harbor” for forward looking statements made by a company. But the act did not specifically do away with the “fraud on the market” doctrine, and plaintiff’s lawyers, being a resilient and resourceful bunch, continued to file securities class action lawsuits. In fact, according to a paper written by Donald C. Langevoort at the Georgetown University Law Center, such lawsuits in the last 15 years have resulted in more than $70 billion in settlements (Judgment Day for Fraud on the Market? Reflections on Amgen and the Second Coming of Halliburton http://scholarship.law.georgetown.edu/facpub/1226 http://ssrn.com/abstract=2281910). This is because, even with the heightened filing requirements, with the fraud on the market doctrine, all shareholders are part of the class of damaged investors, not just those investors that can show they relied upon the alleged fraud. As a result, the class is so large and the potential damages can be so great that almost all securities fraud class actions that survive the pleadings stage wind up getting settled. Which, coincidentally, generates large fees for plaintiffs’ lawyers.


Now, however, the Supreme Court is taking a second look at the “fraud on the markets doctrine. Arguments in the case of Erica P. John Fund v. Halliburton Co. will be heard shortly and four of the Supreme Court justices are on record as opposing the fraud on the market doctrine. If the court reverses the doctrine, or even if they significantly curtail it, the upshot will be a lessening of class action securities lawsuits. For the first time since 1988, plaintiffs will have to actually prove that they were aware of, relied upon, and were damaged by the corporate statements they allege are fraudulent. Wouldn’t that be something? 

Thursday, February 6, 2014

CVS, Tobacco and the Economically Rational Decision

Yesterday I was interviewed by a reporter for National Public Radio’s Marketplace program regarding the decision by CVS Drugstores to stop selling tobacco products. You can find the article here: http://www.marketplace.org/topics/business/why-cvs-giving-smoking. I’m always happy to talk to the people at Marketplace, as it’s one of the few programs on National Public Radio that takes an even-handed approach to business affairs.

The issue of drug stores and pharmacies selling tobacco products is not new. The question used to get asked back in the 1990s when I was doing investor relations for Walgreens. The reason the question came up back then is that the provinces in Canada had begun to ban the sale of cigarettes in pharmacies beginning in 1994. Today, all but one province in Canada bans the sale of cigarettes by pharmacies.

What is interesting here to me is the communications aspect of this situation and how it compares with the business realities of selling tobacco. CVS has, of course, positioned their decision as the morally right thing to do. They are a healthcare related company, and they shouldn’t be selling products harmful to the public’s health. The decision has great appeal to a majority of people and earns them lots of good will. 

Underlying all of that may be other reasons that CVS has gotten out of the business of selling tobacco. In business school terms, what CVS has done is to compare the net present value of the profit stream it would receive from continuing to sell tobacco to the potential profit it will receive by virtue of being more closely associated with a healthcare image and the additional business that will bring in, both on the consumer and the health care benefits sides of their businesses. In this case, they have decided that healthcare is a better business choice, plus it makes them appear to be on the side of the angels.

However, here are a few business reasons why CVS may have gotten out of the business:
1. Tobacco usage has been declining in the United States for many years and the trend shows no signs of bottoming out.
2. Cigarettes are a relatively low gross profit margin product, with margins I estimate in the 15 – 16% range compared to an average of 30% for general merchandise in drug stores.
3. Typical sales in drugstores are for one or two packs of cigarettes at a time, meaning that you don’t make up for a low margin sale by having a big dollar sale, as you would by selling a carton.
4. With prices per pack as high as they are, smokers tend to be price sensitive, meaning that they are not your normal, loyal customer.
5. High prices also lead to more internal theft in this category than many others.
6. Local regulations prohibiting the sale of tobacco to minors leads to a headache at the cash register as clerks need to verify the age of many purchasers. 

So when the dust settles, CVS will have given up 2% of its revenues, but much less than that of its profits. Plus they probably looked north of the border and realized that the Canadian drug store industry hasn’t gone into a death spiral since they were prohibited from selling cigarettes.


All of this also helps to explain why you won’t see CVS eliminating the sale of salty snacks, sugary drinks of candy any time soon. All of these products don’t fit with the image of a healthcare provider, but they don’t share the same business trends as tobacco, so CVS will make the economically rational decision to keep selling them.

Wednesday, November 13, 2013

Tell Me a Story

I wrote in October about the importance of using a variety of delivery methods in order to help your audience learn from and retain what you are saying. Because this is a blog about investor relations (mostly, although I confess to straying from the topic from time to time), today I want to expand upon this idea in one way that can help companies better get their message to Wall Street. In short, stop thinking of investor relations as simply a conduit of information and start thinking of it as a way to also tell a story about your company.

The meat and potatoes of any investor relations program is the ability to convey to investors basic financial information that relates to the company. There is no getting around this - it forms the core of all subsequent discussions. Yet this information often falls into the boring, but important category. Additionally, there are at least two problems with this data. First, unless you are among the lucky few companies that are showing outstanding growth and financial performance, it’s easy to get lost in the shuffle. As they say in the entertainment business, there’s no hook. Secondly, information about past performance does not always give investors a good idea of where the company is going in the future, nor does it give a sense of the way the company operates. This is where making it memorable by telling your story becomes important.

Building upon basic financial information is a critical factor in helping a company stand out from the crowd. When you combine this with the fact that most people learn and retain information better when they get it from a variety of sources, you can begin to appreciate why investor relations should be more than drafting the next press release. Being able to place your company into context in terms of your industry by telling the story of your company is an example. People remember stories. If your company relies on product development, being able to tell the story of how a product was developed can bring context to the bare fact of how much you spent on research and development. This concept can be transferred to almost any industry, be it oil and gas development, retail or consumer goods, to name a few. 


After all, companies are a collection of people, and where you have people you have stories to tell about how those people create unique approaches to the way they do business. How those people set your company apart from other operators and cause it to be unique are integral parts of the story that mere financial numbers can’t tell. It is in providing this context in a memorable fashion that investor relations can add value.

Thursday, October 31, 2013

Are You Talking About What You Want to Say or What Your Investors Want to Know?

I confess that I’m not an avid reader of much of what gets churned out in the business press by the so-called experts. I readily admit that this is somewhat of a contradiction in me, because I want people to read what I write about in my area of expertise, but let’s face it, there’s a lot of crud out there. Most business writers seem to approach their subject as if it were the key component to business success. If their readers would simply follow their cookbook formula, everything would be peachy. If only life were so simple. So I tend to restrict my reading to The Wall Street Journal, The New York Times, The Economist and a few other assorted publications.

One of the other assorted publications I tend to pay attention to is the McKinsey Quarterly, and it is an article there that spurs me to write today. The article, which was published early in October, 2013, is entitled “How B2B companies talk past their customers” and it examines the gap between the messages that suppliers send to their customers and what their customers really want to know. The article struck me as particularly germane to investor relations because, stripped to its bare essentials, IR is a business-to-business marketing effort where companies present the reasons to own their stock to sophisticated purchasing managers who are interested in buying a commodity that will benefit their customers, such as mutual fund investors or pension managers.

The article, which is available at http://www.mckinsey.com/insights, looked at how companies in the business-to-business sector positioned their brands and came up with a list of 13 broad themes and topic areas ranging from the practical (low prices) to the lofty (corporate social responsibility). Then the authors turned around and asked customers how important they thought each theme was in evaluating the brand. What they found was that there was an almost complete mismatch between what companies were saying and what customers thought was important.

This piece of research is instructive to investor relations because IR departments are formulating brand messages all the time, whether it’s in an investor presentation or an annual report, yet in my experience, the vast majority of all such messages are put together based upon what the company wants to say, not what investors want to hear.

So here’s a radical thought. The next time you put together a presentation, stop and think about what investors want and need to hear. This shouldn’t be terribly difficult, as IR departments are constantly bombarded by questions from analysts and good investor relations practice dictates that you should track the types of questions being asked. The data should be there – you simply have to integrate it into your message.


At the end of the day, it comes down to a relatively simple rule of communications – know your audience. Unfortunately, it is a rule that is often overlooked when polishing IR presentations and annual reports.

Tuesday, October 1, 2013

Make It Memorable


One thing I have learned from teaching over the past six years is that if you want your audience to not only learn, but also remember what they learn, you have to make it memorable.  There are many ways to do this – you can speak with passion, you can use humor, you can have catchy phrases and acronyms, you can even (heaven forbid) have a catchy PowerPoint presentation – but what you are saying and doing has to catch and hold the audience’s attention. In a way, it is education as theater, and it is particularly effective in an adult education setting where the distractions of emails and messages from the office are a constant challenge.
Last week I attended the NIRI Southwest regional conference in Ft. Worth and it reinforced my opinion that the Southwest regional conference is a better overall learning experience than the NIRI national conference. I have a variety of reasons for saying this, but for today I want to focus on the educational aspect of the Southwest regional conference. The national conference seems to be locked into a format that is heavily dependent upon panel discussions featuring panelists that are long on narrow technical expertise and short on speaking skills. This was true a year ago when I attended in Seattle and a quick review of the 2013 National conference agenda reveals that the vast majority of the sessions continue to be panel discussions. The result of many panel discussions viewed in quick succession is the verbal equivalent of Chinese water torture – many words delivered in a monotone, leading to eventual brain damage. 
The Southwest regional conference, in the years when it has been organized by the Houston chapter, has broken from this mold. In 2010 and 2012 the conference featured a case study that forced attendees to work together and make decisions. They went beyond that and introduced several new formats to the conference this year. (Full and fair disclosure: I was on the conference planning committee, but due to my move back to Chicago, cannot claim much credit for the work of the planning committee.) In addition to the usual speakers and panel discussions, the conference introduced an interactive case study based on a real life example (featuring yours truly), a point - counterpoint style debate featuring practitioners discussing current hot topics in IR, an IR version of the dating game where IR officers try to convince an analyst to cover their company’s stock, and my favorite, three short (20 minute) TED style talks where people addressed issues near and dear to their hearts with passion and conviction. The result was a mix of information delivered in memorable fashion that consistently engaged the audience.
When you are in investor relations, a key element to what you do is communication. I can only hope that the National Investor Relations Institute takes note of how the Southwest regional conference is expanding the communication boundaries in order to help people remember what they learn at conferences and become better practitioners of investor relations. After all, isn’t what these conferences are all about?

Tuesday, July 23, 2013

Lights! Camera! Earnings Call!!


Lets face it – earnings calls are boring. Lawyers will tell you that this is a good thing because you are far less likely to get sued or have regulators come down on you if you don’t do anything splashy. So for most companies the earnings conference call has evolved into an elaborate kabuki theater consisting of 20 – 25 minutes of prepared remarks followed by 25 – 30 minutes of questions from analysts.
The prepared remarks are the worst – many times all you get is a regurgitation of the earnings press release, proving only that the CEO and CFO can read. This is because lawyers, ever fearful of Reg. FD, are reluctant to allow even the smallest snippets of information to vary from what has been “broadly disseminated” in a press release format. So you wind up with a highly paid executive reading dishwater dull financial information to analysts and investors who have already read the press release and put the numbers in their models. My guess is that with earnings season being notoriously busy, most analysts are only listening with half an ear to the prepared remarks while they multi-task on other things.
The question and answer sessions are a bit more interesting, if only because there is some uncertainty at work, both in the questions that are asked and the answers given by executives. Keep in mind however, that companies have a system for controlling who gets to ask questions, and when on the call the questioner will appear. Thus invariably, the company’s favorite analyst (read “biggest booster”) will get the cherished first question position, and the question is likely to be one that management has no difficulty answering. Thus analysts are often reduced to the role of the old Kremlin watchers, where  more information is to be gleaned from nuance, voice tone and innuendo than in the party line answers executives spout.
Now, however, the earnings call may be starting to evolve. Last week Yahoo’s CEO and CFO presented a live webcast of its second quarter earnings call. In most respects, their webcast was just like an earnings call, except you could see the executives. Thus, in addition to voice tone and inflection, analysts and investors could also judge body language. This also means that, unless it was done off camera, no one could surreptitiously slip answers to the executives. This is perhaps a small step, but it does add a few more points that investors can use in judging management.
A few days later, Netflix also broke with the typical earnings call with a slightly different format. In their presentation, which was conducted on Google Hangout via webcam and posted to YouTube, Netflix dispensed with the prepared remarks entirely and went directly to questions and answers. This is probably a good development, as it avoids needless repetition of financial information. The questions were compiled beforehand and posed to management by a reporter and an analyst. This may be a less salutary development, as it favors a single analyst and reporter, and while the company says that it did not see the questions beforehand, this process may be open to manipulation. In addition, because many of the questions were composites, there was no attribution of questions to any particular analyst, which I’m sure did not please the sell side community.
In general, both presentations were well received as bringing something new to the staid conference call format. I can only hope that more companies start to push the envelope in order to make things more interesting and to stand out from the crowd. Because, with disclosure to investors, as with classical economics, more is better - at least until you get to the point of disutility…