Thursday, July 26, 2007

The Da Vinci Code (Securities Analyst Version)

The job of a securities analyst has been likened to that of a person assembling a mosaic of information to come up with an investment thesis, or as I like to think of it, cracking a code. Indeed, the Securities and Exchange Commission, in their adoption of the final rules for Regulation Fair Disclosure stated:
“[A]n issuer is not prohibited from disclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer, that piece helps the analyst complete a ‘mosaic’ of information that, taken together, is material. …Analysts can provide a valuable service in sifting through and extracting information that would not be significant to the ordinary investor to reach material conclusions.”

While it’s nice to know that the Securities and Exchange Commission thinks that analysts can provide a valuable service, the key point here is the recognition that information comes from multiple sources. When you are involved in the corporate side of investor relations, as I was for over twenty years, you sometimes lose sight of this fact because you are striving to be the sole source of information not only on your company, but also on the industry. My mental picture of what analysts do, built up over a number of years, is that they talk to the companies under their coverage and in their industries, work on their models and come to an investment decision based upon that work. There seems to be precious little time devoted to alternate sources of information.

But, in fact, alternate sources of information have become ever more important since the adoption of Reg. FD. The reason for this is that corporate disclosures have become increasingly bland since the regulations came into effect in October of 2000. I can’t cite any statistic on this other than the fact that ever more lawyers have become involved in corporate disclosure. This point was driven home when, in an enforcement action in 2003, the SEC noted that Schering-Plough violated Reg. FD "through a combination of spoken language, tone, emphasis, and demeanor. In other words, you can’t look or act depressed when talking to investors. What corporate lawyers will tell you now is that unless things are on an even keel, it is dangerous to engage in one on one meetings and discussions with analysts. Of course, when things are not on an even keel is exactly when analysts want increased information flow.

Capitalism being the wonderful thing that it is, (and what’s more capitalistic than Wall Street?) the market has reacted to provide alternate sources of information for investors. There is a whole new sub-industry, the so-called expert networks that can get information about any company, product or trend you are looking at. There has been an increase in research shops that concentrate almost solely on channel checking with suppliers, customers, franchisees and, if they can get them to talk, employees. Of course, corporate investor relations officers dislike most of the alternative information sources because they can’t control the message and they often don’t know the source.

So what’s the best way to crack the code? If you are an analyst the thing to keep in mind is that when you talk to the company you will be told that the Mona Lisa is in fact a picture of a very nice lady. Because they answer questions about the picture all the time, they will be very good at describing everything in the picture that favors the company. They certainly won’t tell you where the code is hidden in the picture. Just as in the book, if you find information in the picture that indicates there is something more there than meets the eye, it will require considerable effort and multiple sources to figure the darn thing out. Oh, and the keepers of the picture won’t be happy with you, although it’s highly unlikely anyone will shoot at you.

If you are a corporate investor relations officer, the thing to keep in mind is that the more you stick to “the message” the more likely you are to drive your audience to alternate sources of information. There is room for nuance and difference of opinion about corporate performance. But, you have to admit; it is a very nice picture of a lady…

Wednesday, July 11, 2007

What Was He Thinking?

Occasionally during my career in investor relations I have run across a situation that so surprised me my only reaction was amazement and the thought “What was he thinking?” I thought it might be instructive to share a few of these war stories in the hope that people will learn from what I saw.

In the late 1990s, I was working in New York for a money management firm when we hosted a on-on-one meeting for the CEO of a large grocery store chain. In the room were 5 - 6 portfolio managers, the analyst following the company, the CEO and one other company representative. During the course of the meeting the CEO went to great lengths to describe how he and his management team were constantly out looking at their stores and the competition. After a detailed description of what they went through during the course of visiting stores, the CEO casually said, “After a long day we all go to Hooters to sit down and compare notes.”

I remember looking across the table at the analyst who followed the company, who was a woman, and watching her face turn to stone. I mean, “What was this guy thinking?” Did he really think that a professional New York woman would think highly of him for going to a place like Hooters? It was a superfluous detail that completely sank this man’s credibility.

A second incident also occurred while I was working at the money management firm. In this case, the CEO of a major fast food chain was doing a one-on-one conference and was describing their new initiatives to better prepare meals that would be to fresher and more appealing. During the course of all of this he came out with the statement “You know, we were so involved with our promotions and product placements that we forgot we were a food company.”

Now this is a very honest and forthright thought and I’m sure the CEO was being sincere when he said it, but “What was this guy thinking?” In internal company meetings you might discuss having lost sight of your core competency, but not to a room full of portfolio managers who hold millions of shares of your stock. I remember thinking at the time, “Why do we own this stock?”

So what conclusions can you draw from these two examples, other than CEOs occasionally suffer from foot in mouth disease? Start with the premise that there are no throwaway lines. Virtually everything you say may be held against you. This is also true when an analyst is visiting you. From the time they start to make the appointment for the visit, to the appearance of your offices to what kind of cars are in the parking lot, it is all being assessed. So what you are saying had better match up to the reality the analyst is seeing. If you are preaching cost controls, you had better not have lavish artwork in your offices or lots of Mercedes and BMWs in the parking lot. If your company mantra is customer service, then the process of making an appointment should be handled with efficiency and courtesy and you darn well better return all phone calls promptly.

Secondly, you always need to be aware of your audience. Most New Yorkers wouldn’t bat an eye if it somehow came out that your sexual orientation was not completely hetero, but would be aghast at the thought that anyone would patronize a place like Hooters. Of course, the foregoing is not necessarily true in other parts of the country, so discretion is advised.

Finally, you can be too honest or candid. I know because I’ve found myself in this position from time to time. A person talking to investors needs to keep clear in their mind the difference between and inside audience and an outside audience. Sometimes this can be difficult if you have a long-standing relationship with an analyst and you want to explain something in the context of a company’s culture. It is compounded by the fact that an IRO’s job is to provide context and color to the financial results. In the end it requires good business judgment. And luck…

As always, your comments are welcome. Please let me know of other war stories where CEOs have shot themselves in the foot. We will keep everything anonymous to protect the guilty.