The Readers Vote

I’ve been writing this blog for about 18 months now and being a trained MBA, thought it would be a good exercise if I went back and reviewed the statistics around what people preferred to read.  After all, “If you can measure it, you can manage it”.  Besides, I thought some of my readers might find it interesting as well.  Additionally, if you are relatively new to the blog, there might be something I’ve written in the past that may be useful.

After 18 months of building up a readership base, Investor Relations Musings draws between 800 – 1,300 readers per month, which when you consider that there are only approximately 6,500 publicly traded companies in the U.S., isn’t bad.  More surprising to me, is that during those 18 months, I’ve had visits from 77 different countries, with any given month drawing from 30 – 35 different countries.  Although the vast majority of readers come from the U.S., 5 of the top 10 countries visiting the blog come from India, China and the Far East.  

When I examined the most popular posts, I found that the interests of readers were evenly split between humor, practical advice and the disaster of the moment.  Herewith a look at the top 10: 

1.  Essential Life Skill for the Investor Relations Professional, September 18, 2007.  A humorous look at what you need to survive in the profession, with tips about how to learn to talk with your mouth full.

2. Starbucks Grande Mistake, January 31, 2008.  My take on Starbucks decision to stop disclosing same store sales.  It turns out that people love to read about brand name companies.

3.  Why Not Just Tell Us Why You Fired Him?, October 14, 2008.  When Walgreens CEO was dismissed by the Board but it was gussied up as a “retirement”, my thought was that investors deserved better information about why he was fired and what it meant for the future of the company.

4.  Road Shows and Hedge Funds, November 12, 2007.  A look at the practicalities surrounding why sell side firms set up road shows with lots of hedge funds on the guest list.

5.  How Many Investor Relations Officers Does It Take to Change a Light Bulb?, June 8, 2007.  This one combines humor with thoughts on what it takes to be good at investor relations.

6.  How Not to Run a Conference Call, December 20, 2007.  Commentary on Sallie Mae’s disastrous conference call.

7.  What is Investor Relations Worth?, August 20, 2007.  The first of a series of posts pointing out the research that attempts to quantify the value of investor relations.

8.  Principle Based Disclosure for Investors, September 5, 2007.  Some thoughts on how to simplify the maze of regulations surrounding disclosure.

9.  How to Read 10K and 10Q Reports, September 10, 2008.  CVS Drugstores was a poster child for how investors can use the year over year change in language in 10K and 10Q reports to raise interesting questions.

10.  Blogging and Investor Relations, June 16, 2008.  Every IR officer wants to know about blogs, but nobody wants to do one (except Dell). 

If you haven’t had a chance to read these posts, I hope you’ll give them the once over.  As always, I will strive to be interesting, informative, opinionated and occasionally humorous. 

Starbucks and Disclosure of Same Store Sales

Last January, Starbucks announced that it was no longer going to provide same store sales numbers to investors as it executed its turnaround strategy.  At the time I said it was a mistake (see my post “Starbuck’s Grande Mistake” January, 31, 2008) and I still continue to think so.  But it’s been almost a year and I thought I would go back and see what Starbucks has done on this single, but important, disclosure item.

On a quarterly basis, they’ve been true to their word.  In the third quarter of 2007, before the ban on disclosing this metric, Starbucks’ press release mentioned comparable store sales 11 times, including citing the percentage increase as a highlight.  The 10 Q report for the same period mentioned comparable store sales 16 times.  (Lest anyone out there think that I am a geek sitting here counting words, let me assure you that my computer performs this task much better than I can.  It’s extremely useful when comparing one period’s reporting to another.  See my post “How to Read 10 K and 10 Q Reports, September 8, 2008.  I may be a geek when it comes to investor relations, but I’m not a total geek.)

Now move forward a year to the third quarter of 2008.  Starbucks’ press release only mentions comparable store sales twice.  The first time, in discussing sales results, they say: “The company’s lower than expected revenue growth was driven by continued slow traffic trends in the U.S., which resulted in a mid-single-digit decline in U.S. comparable store sales, and was a slight deterioration from the second quarter.”  So now Starbucks has taken away a lot of discussion and precise numbers from a year ago and replaced it with ambiguity.  If I’m an analyst and I hear “mid-single-digit”, my reaction, fair or otherwise, is that the decline is in the upper end of that range.  In the same release, of even more interest, is the way Starbucks phrases things when discussing their targets: “These targets reflect the company’s current assumption that fourth quarter company-operated comparable store sales trends will remain relatively stable with the third quarter.”  As someone who has written his share of press releases, I’ve got to admire the way Starbucks took a trend of mid-single-digit declining comparable store sales and made it sound stable.  In a fashion similar to the press release, the 10 Q report for the same period only mentions comparable store sales 3 times without citing a specific amount.

So when I went to this year’s Fourth Quarter Press Release and Annual Report on Form 10 K, I expected to see a similar dearth of discussion surrounding comparable store sales.  To my surprise, I found that this year’s 10 K actually has more mentions of comparable store sales this year (22 vs. 20), while the Press Release saw a moderate decline in mentions from 13 a year ago to 9 this year.  Not only that, but both the release and the 10 K filing mention specific numbers when discussing comparable stores sales. It was one of those moments when you lean back from your computer screen and go, “Huh”.  It also meant a lot more work, because now I had to go through the 10 K filing in detail to try and figure out what was going on. What I found was that this year’s Management’s Discussion and Analysis contained slightly more mentions of comparable store sales than in last year’s report, while everything else in the filing was pretty much the same year over year.  It was as if Starbucks had never changed its mind on disclosing the metric.

Obviously, I’m not privy to the internal discussions Starbucks has when preparing their securities filings, but, in my opinion, one of two things happened: either the accountants and the lawyers simply marked up last year’s 10 K and nobody else paid any attention to the filing (unlikely given that the 10 Q reports had significantly fewer mentions of comparable store sales) or the lawyers finally got some backbone and said something along the lines of, “Look, this number is so important and the trend is so significant, that you have to disclose it and talk about it.”  I wish I could have been a fly on the wall during those discussions.  Whatever the reasons, I am glad to see that the company is disclosing such an important number.  It would also appear that the company is continuing to discuss comparable store sales, as they discussed them at an analyst conference yesterday.

The takeaway for investor relations professionals for all of this is that you can’t hide important metrics about your company when the trend turns bad.  When Starbucks stopped disclosing same store sales numbers it was just as the numbers were headed south after many years of strong positive sales growth.  If the numbers were important when they were good, they are important when they are bad.  All Starbucks did was postpone the inevitable to the end of the year.  It was very short-term thinking on their part to think that they could spin the issue when it revolved around such a key number.

Some of My Favorite (IR Website) Things

Now that Thanksgiving is over, I thought that I would get in a Christmas holiday mood by listing some of my favorite (IR website) things. (Obscure fact of the day: The song “Some of My Favorite Things”, was sung by Julie Andrews in the movie The Sound of Music during a Summer thunderstorm, although it is now mostly associated with the holidays due to its optimistic lyrics.)  I’ve been working on a project lately that scores investor relations websites and it’s given me the opportunity to view many companies’ efforts in this area.  Overall, it seems as if investor relations web sites are becoming more robust.  I’ve been impressed with the variety and ingenuity exhibited on some of the sites I’ve seen.

As you might expect, not every site does everything, so for the benefit of those investor relations officers that don’t have time to conduct a review of other web sites, I thought I would list some of my favorite features:

Charting – there are lots of charting sites available, but some things can be done better on the company page.  For example, interactive charts with links to events and press releases are very helpful.  Many times I’ve stared at a stock price chart with a big dip or rise and wondered, “What happened here?” An interactive chart that leads you straight to the event saves a lot of time and effort.  Another helpful feature is being able to specify an exact time frame for your chart.  After all, most investors don’t invest on the exact day necessary to fit into the standard time range specified on most web sites.  I also found that charts that let you specify other companies to chart against very useful, although I’m sure many companies are not thrilled about having their competitors charted on their site.

I also found sites that provided a glossary helpful.  Every industry has its acronyms and special catch phrases and to the extent these can be explained and accurately defined, a lot of questions and head scratching can be eliminated.  In retail, for example, a common measure is same store sales, but many companies calculate it slightly differently.  A clear definition of how the measure is calculated can save IROs a lot of heartburn.  Along similar lines, another interesting feature I came across was a page that discussed other, non-company indicators as they may affect the company.  An obvious example, (I live in Houston) is the link between the price of oil and the performance of the oil companies.  Other companies have exposure to things such as inflation, commodity prices and consumer spending to name a few, and a page where companies gather the data and discuss their outlook on these trends is quite useful not only as a data source, but also as an additional insight into how the company thinks about how it is linked to the greater economy.

Finally, while most companies today provide links to their recent earnings conference calls, very few provide a transcript of the call.  Although you miss the tenor of the speaker’s voice when you rely upon a transcript, it is a more time efficient way of reviewing a conference call.  It would be fairly simple for most companies to post a transcript and save us all the additional hassle of going over to the Seeking Alpha web site to get it.

There are still plenty of IR sites out there that look as if the task was simply handed off to a third party provider with the lowest price option selected (frequent readers of this blog will know that I am generally incapable of writing a post without saying something critical), but overall my assessment is that the amount of data being presented is increasing and the ease with which investors can use the information is getting better.  So, from an investor relations standpoint, things are improving.  Now, if we could only say that about the economy…

Putting a “Hook” into Your IR Message

In the music business, received wisdom is that a song needs a “hook” if it’s going to be a number one hit.  In other words, a song has to have a memorable thought, idea or catch phrase so that listeners will remember it.  The idea translates well into much of what we do in investor relations.

Yesterday Robin Tooms of Savage Brands and I put on a Webinar entitled, “Attracting Investors with a Strong Financial Brand".  For me, it was an opportunity to step back and think about some of the more strategic aspects of investor relations. In IR we are often consumed with the tactical issues; the latest earnings release, the next investor conference, the endless minutia of analysts’ questions and the like, and we fail to put things in a framework that help investors understand what our companies are all about.  Thinking of your company as a financial brand helps to put your company in a context where many of the things your firm does fall into place and help explain one another. 

Some companies have such strong cultures that their financial brand is easy to see. The example I spoke about on the Webinar was Wal-Mart.  Everything Wal-Mart does is predicated on delivering the lowest possible price to their customer.  Their philosophy is simple – if you deliver low prices to customers, they will shop in your stores in large numbers and you’ll make lots of money.  Once an investor understands that this low price philosophy permeates everything that Wal-Mart does, they have a much better understanding, not only of the financial implications (gross profit margins low, SG&A even lower), but also how Wal-Mart gets there through its relationships with suppliers, cost containment and even their passionate anti-union stance. 

Sometimes it’s not quite as obvious and it takes a little thinking about how you should be positioning the “brand”.  When I was at Walgreens, the stereotype of the company was that it was just a drugstore chain, which as all the analysts knew was vulnerable to: (pick one, depending on the decade) combination supermarkets/drugstores, deep discount drug stores and Wal-Mart and hence could not possibly be competitive on price. In addition, nobody could understand why the company was building so many stores so close together, as there were already plenty of drug stores in America in retail shopping centers.  (As an aside, allow me to add that Wall Street analysts are notoriously bad at strategic thinking about companies.  Companies that allow Wall Street to set their strategic agendas are almost certainly doomed, as they will be buffeted by the latest trends taught in business schools unrelated to the hard facts of the marketplace and the company’s underlying culture. (See my post, “When Culture Meets Financial Theory” from September 24, 2008.)  It’s even worse than when the company brings in a bunch of consultants to help set the future course of the company.)  The response, or “brand message” to all of this was simple: Walgreens sells two things – healthcare and convenience.  When put into that context, much of what Walgreens was doing became more understandable.  The competitive response to the various retail formats, all of them big box retailers, was to be more convenient.  This explained why price, which Wal-Mart has used so effectively on most competitors, was not as effective on Walgreens, because Wal-Mart, with their giant stores, just wasn’t convenient.  It also explained why Walgreens was building so many stores – you needed to be close to the customers in order to be convenient.  And it explained why Walgreens wasn’t buying a lot of the existing drug stores, as those stores sat back in shopping centers right next to the supermarkets and were not as convenient as the new stores Walgreens was building on busy street corners.  The list goes on, but I think you get the idea.  Walgreens stated what made it unique and used it to explain many aspects of its operations and philosophy. 

We operate in a time when our message to investors is at risk of becoming ever more fragmented as the means of delivering it proliferate.  Think about Twitter – how do you convey a coherent message in 144 characters or less?  Either that or we run the risk of becoming increasingly bland as Reg. FD forces companies to be relentlessly on message.  If you can go beyond the tactical considerations of what the regulations require to be disclosed and whether or not something is material to provide a coherent context to your company – a financial brand – you will help your company and increase your value to investors. 

Either that, or you’ll be ready for a career in marketing…

The Curious Effect of Falling Stock Prices on Diluted EPS

As I’ve watched companies report earnings for the quarter that ended September 30^th, I’ve noticed a strange phenomenon – companies are getting help to their Diluted Earnings Per Share line from falling stock prices.  It’s no secret that the stock market has been brutal over the course of the past six months, and company equity values have taken a beating.  But there has been one small side benefit to the decline in stock prices.  Of course, companies won’t come out and tell you what it is.  You have to be a pretty savvy investor and know your way around a company’s financials in order to figure it out. 

Here’s how it works:  many companies have issued a large number of options over the last decade and have a large number of options that go into the diluted earnings per share calculation.  To grossly oversimplify things, the more options a company has outstanding and the deeper they are in the money, the greater the number of shares in the denominator for purposes of calculating diluted (as opposed to basic) earnings per share.  So far, so good, as long as the stock price moves in a smooth fashion.  However, when you get a steep drop in the stock price, many of a company’s options go under water.  When an option’s exercise price is above the fair market value of the stock, the options are excluded from the diluted earnings per share calculation, and they are anti-dilutive.  (This sounds to me suspiciously like anti-matter, but I don’t think accountants are that imaginative.) The result is that companies with large numbers of stock options and steep price drops in the stock price wind up with fewer fully diluted shares in their diluted EPS calculation and hence a higher diluted EPS number.  Good luck getting them to fess up to that however, they do their best to bury the calculations deep in the 10K or 10Q.

Sometimes the numbers can be startling.  A few years back Microsoft had 649 million shares excluded from the calculation of diluted EPS because they were anti-dilutive.  Talk about a big overhang on EPS if the stock price ever recovers.  More usually, the anti-dilutive effect is smaller, say one or two cents per share in each quarter.  The point here is two-fold: first, in Wall Street’s eyes, one or two pennies per share per quarter is a lot; when companies miss by that much, they get punished; and second, this is a non-operational benefit that companies are getting due to the bear market.  Companies are quick to tell you when non-operational issues hurt the EPS line, so why do they stay so quiet when it runs in their favor?

Finally, as long as I’m on my soapbox, where have all the highly paid Wall Street analysts been on this issue?  I have not seen a single analyst report that mentions this.  So here’s some advice to all my sell side friends – when diluted and basic EPS suddenly start looking the same where in previous years diluted was lower than basic, the company is probably getting some non-operational help from anti-dilutive options. Things aren’t as good as they seem.

Now, just like anti-matter coming into contact with matter, I will disappear.

Greek Classics Revisited

For those of you who may think that the current financial crisis is unique, I would submit that this type of drama goes all the way back to ancient Greece.  In many ways, what we are seeing resembles the Iliad (minus the blood, gore and interventions by the gods, but otherwise pretty close).  Before you claim I’m totally off my rocker, consider the plot of the Iliad:

Agamemnon and Achilles quarrel over the distribution of riches; Achilles goes off to sulk in his tent; the war goes on without Achilles; Patroclus, Achilles friend, goes off to fight pretending to be Achilles; Hector slays Patroclus; Achilles slays Hector; Achilles and Priam, Hector’s father, weep together at Hector’s funeral.

Now consider the current financial crisis:

Congress and the Treasury Department quarrel over the distribution of the $700 billion rescue package; the House of Representatives goes off to sulk and refuses to pass a bill; the crisis goes on without Congress, with the equity markets declining by record amounts the day after Congress fails to pass the package; Paulson and Bernanke attempt to quell the financial markets without the backing of Congress; the markets collapse worldwide; Congress passes a rescue bill that limits some of the damage done and finally, Congress holds hearings and weeps over the failure of Allen Greenspan to warn of the dangers of the deregulation in the financial markets.

It almost makes you think that there may still be Greek gods out there staging all of this for their own amusement.

Just to top this analogy off, students of Greek literature will remember that the Iliad was followed by the Odyssey.  This means that we will still have to deal with the Sirens (think about all those pitches for alternative investments that could diversify your portfolio), witches that turn men into pigs (think about what’s happened to your 401(k) account lately) and navigating between Scylla and Charybdis (found any good place to put your money yet?).  Oh, and by the way, it took Odysseus ten years to get back home.

On that happy note I will bring this post to a close before I sound like a Greek chorus.

Looking at Fact Patterns

The image investor relations people have of investors is that they sit at their computer monitor all day long and review spreadsheets.  The reality is more complex, but many of the most astute investors I know rely as much on tangible fact patterns as they do on crunching the numbers.  A portfolio manager that I have great respect for once told me, “When you hang around this industry long enough, you come to recognize certain fact patterns as red flags that merit greater scrutiny”.  Here are a few that I have encountered over the years:

Sudden Departure of Key Executives

This is most visible when the Board replaces the CEO (See last week’s post, “Why Don’t They Just Tell Us Why They Fired Him?”), but it’s probably just as important when it involves the COO or the CFO.  If a COO leaves unexpectedly, it usually signifies either that the CEO thinks he could run the operations better himself, feels threatened by the COO or there is a strong divergence of opinion between the CEO and the COO on the direction of the company.  None of these is usually good for the investors.  If a CFO leaves unexpectedly, it raises questions about internal controls and accounting systems.

A Sudden Influx of New Executives from Outside the Company

Usually this means trouble as new executives struggle to fit into a corporate culture, or worse yet, try to replace the culture with their own.  For example, one only needs to look at the people Bob Nardelli brought into Home Depot.  They were all performance driven in a GE way, whereas the Home Depot was centered around customer service and decentralized management at the store level.  The result was stores that dropped the ball on customer service and a stock price that went nowhere for a decade.

Constant Turnover in the Executive Ranks

Almost every company will try to tell investors that they have a stable of executive talent that has long tenure with the firm.  These statements usually run along the lines of “Our executive management team has an average of X years with the company.  What they won’t tell you is that they are the ones defining the measurement pool.  What this means is that they can make the measurement pool as large or as small as they want in order to shade the numbers in their favor. It also ignores the people that have been terminated, hired away or even retired.  What investors need to do is to pull out an annual report from a few years ago and see how many of the executives from then are still around.  I did this with a company I’m familiar with and found that of 47 executive positions listed four years ago in the annual report, 19 had left the company, including the COO and the CFO.  That’s a turnover rate of 40%.  If you were an investor that bought that company’s stock four years ago, it could be argued that it’s not the same management team.

A Big New Initiative With Lots of Consultants Directing Events

This usually signifies a large transfer of wealth from shareholders to the consultants.  These projects are usually accompanied by statements from management to the effect that the consultants are only at the company for a brief period of time after which the company will take over the project from the consultants.  About the time the company takes over the project is when the company stops talking about it. (See my September 24, 2008 post, “When Culture Meets Financial Theory”.)  Good luck trying to figure out if the company made a return on their investment.

International Expansion

Usually, when a company makes a big announcement about pursuing international markets, it’s an admission that they are almost out of room in the United States.  Given that international markets are almost always either 1) slower growth (think Western Europe) or 2) higher risk (think emerging markets) and 3) more difficult from a regulatory perspective, this means that shareholders will suffer in one respect or another.  In addition, it may mean that the Chairman and his spouse like to visit Europe a couple of times per year at the shareholders’ expense.

A Sudden String of Acquisitions

Acquisitions are, by their nature, disruptive, both for the acquired company as it attempts to fit into a new corporate system, and for the acquiring company as it siphons off resources to try and integrate the newly acquired company.  When you do a string of these, it has a compounding effect and the risk goes up that management takes their eyes off the ball of the main business. Or worse yet, the combined operations will make the numbers so confusing that rational year over year comparisons can’t be done, leaving investors scratching their heads while they try to figure out what’s really going on.

So if you’re an investor relations officer and are frustrated because you think analysts and portfolio managers don’t understand the underlying value of your company, you might look outside the numbers at some of the surrounding fact patterns to see some other reasons that investors might be leery of your stock.

Why Not Just Tell Us Why You Fired Him?

When a CEO is “Retired” by the Board of Directors investors almost always get the short end of the information stick.  Last week Walgreens Board announced that its then Chairman and CEO, Jeff Rein, retired at the age of 56.  They at least spared us the usual palaver about leaving to spend more time with his family or pursue other interests.  The fact of the matter is that the Board fired the CEO, but didn’t bother to tell investors why.  Readers of this blog may recall that I spent 23 years at Walgreens, 15 of which I had the pleasure of being the principal investor relations contact for the company.  So naturally, I wanted to know more about what went on.  (On a note of full and fair disclosure, I will also tell readers that I am not now, nor have I ever been, a fan of the recently departed CEO.  In fact, disagreement with him was the principle reason I left Walgreens nine years ago.  But then again, in the past few days as I’ve talked to investors, analysts and former employees, I haven’t been able to find anyone who claims to have been a fan.  How do guys like this get to be CEO in the first place?)

When someone as important as the CEO is asked to step down, investors deserve a reason that is credible, not the window dressing we usually see.  In this case I think it boils down to a couple of key issues – performance and strategic direction.  The performance issue is easy to see – under Rein’s watch earnings per share performance became much more erratic and the share price has slumped.  However, I don’t think that alone was enough to do him in.  Probably the deeper and more far-reaching reason for his dismissal was over the future strategic direction of the company and a failure of leadership.

Since the late 1970’s Walgreens has been one of the great organic growth stories in America.  The premise was simple: open ever increasing numbers of drugstores, run them well and ride the rising demographic wave of baby boomers taking more and more prescription drugs as they get older. However, somewhere in the last few years, as the number of new stores opened every year rose to over 300, return on assets and return on equity began to slip and expense ratios began to rise.  This was accompanied by a declared shift in strategy from just running drugstores to investing in other healthcare concepts such as in-store clinics, specialty pharmacy and acquisitions.  If you were viewing this from afar, it almost looked like a Boston Consulting type of strategy – use the drugstores as cash cows to fund faster growing healthcare concepts, but the overall emphasis continued to be on growth. 

Then, earlier this year, interesting things started to happen.  In June, the company hired a new CFO from the outside, an unusual occurrence in a company that prides itself on promoting from within.  One month later the company announce that it would slow its rate of organic drugstore growth and investors started to hear from the new CFO about plans to improve return on assets and rationalization of SKU counts in the stores.  In September, Walgreens announced that it was making a bid to acquire Longs Drugstores, a chain of almost 500 stores on the West coast, which on the surface, seemed to be at odds with the declared goal of slowing growth and increasing returns.  Then it was revealed that earlier this year Walgreens had been in talks with Longs about the possibility of acquiring it.  Finally, in October, Walgreens terminated its bid for Longs after being unable to get Longs to agree and two days later Rein, Walgreens’ CEO “retired”.

So when I try to piece things together, here’s how I interpret things:  There seems to be two competing long-term strategies at Walgreens over the past nine months – one that was committed to growth at any price, and one that recognized the limits to growth and sought slower growth with higher returns.  When the original acquisition talks with Longs did not pan out earlier this year, it would appear that the Board of Directors endorsed a view towards slower growth.  Then, within sixty days of announcing this new strategy, something changed – my guess is that Walgreens’ CEO bought into some new arguments by investment bankers that they could get the Longs deal done – and they decided to publicly pursue Longs.  While technically, the acquisition bid is not at odds with the slowing of “organic” growth previously announced, investors were confused.  Finally, when Walgreens’ CEO couldn’t get the deal done, the Board axed him for both zigging when they had publicly said they were going to zag and failing to be a strong enough leader to get the job done. 

All of this is speculation on my part, and that’s my point as it relates to investor relations.  The Board of Directors at Walgreens did not give any good reason for why the CEO was forced to retire, nor did they offer any indications as to the long-term strategic direction of the firm implied by the ouster.  Investors are left to speculate, which cannot be good for the stock.  These sorts of situations are messy, and I can understand why companies want to keep their dirty laundry hidden.  On the other hand, investors own the company and Boards of Directors act on their behalf.  Clarity on why the Board acted and what it means for the future direction of the company should be the least we can expect in terms of good corporate governance.

Questions You Should Prepare to Answer During This Market Downturn

Wall Street has a saying, “You can’t fight the tape”. What this means is that when the market moves in a given direction, in this case down, any prospect of your stock not getting caught in the downdraft is remote. The best you can hope for is that you suffer less than most. (Of course, there’s another saying that goes “The trend is your friend”, but that clearly isn’t the case these days). As we watch fear ripple through the market, I thought that it might be helpful if we paused and thought about what investor relations officers can do to bring some semblance of rationality to the valuation being assigned to their companies’ stock.  The concerns of investors that need to be addressed revolve around short-term issues and long-term prospects. 

On the short-term side of the equation, the biggest concern is always liquidity. How exposed is your company to the lack of liquidity in the markets?  Obviously, this is a huge concern for financial companies and companies with large amounts of leverage, but there are many other companies out there that routinely rely on short-term borrowings to fund operations.  With the credit markets locked up, how much cash does your company have to fund its operations? What are your alternative sources of credit? How is your cash conversion cycle being impacted?  Are your creditors paying you on time? What sort of write-offs are you looking at from your receivables?  How liquid are your inventories? Are you engaged in a stock repurchase program just when you should be conserving cash?  These are questions that every investor will want your input on, because they will be thinking about these issues. 

On a longer-term perspective, it is likely that we are headed into a recession and the natural questions that come up will revolve around this issue.  How economically sensitive is your company’s business?  What has been its performance in previous downturns?  Will tighter lending standards impact your sales? Is your company tightening the credit it extends to its customers?  What’s the longer term funding status look like for your company – are there large debt repayments coming due in the next few years?  How are you positioned relative to your peers with respect to all of the above? Institutional investors continue to be measured relative to a benchmark, so to a certain degree, they may be more willing to hold your company’s stock if, from a relative viewpoint, either your sector or your company are better positioned to perform during tough economic times.

Now is the time for investor relations officers to communicate more rather than less.  Professional investors are feeling quite a bit of pain these days as the markets gyrate wildly.  They are much more likely to pull the trigger and sell your stock if you don’t have immediate, well thought out answers to their questions. 

What Went Wrong With the Bailout

First of all, let me say that I have the utmost respect for Hank Paulson.  When I worked at Walgreens, Hank was the Goldman Sachs partner in charge of Chicago and I had the pleasure of dealing with him on a number of transactions.  He has a terrific knowledge of the financial markets and knows how to get things done on Wall Street.  However, that doesn’t necessarily mean that he knows how to get things done in Washington.  Herewith are a few modest suggestions that could have helped get the legislation through the halls of Congress, based on my years of dealing with communications issues, investors, and corporate management.

Naming

The people at Treasury never should have let this proposal see the light of day if it was going to be called a bailout.  They should have labeled their efforts the “Financial Securities Reform Act or, better yet, something that made a snappy acronym that highlighted the fact that they were going to take charge of the markets and wrestle down to earth all of these mortgage backed securities and collateralized debt obligations.  The agenda should have been reform, not bailout.

Offer Terms

Treasury treated Congress as if it were corporate management of a bank that was about to be seized by federal regulators.  The original proposal for legislation contained provisions that simply were not politically palatable to Congress – giving huge new powers to Treasury that were not reviewable by Congress or the Federal Courts and putting no limits on corporate compensation of executives of firms that benefited from the legislation.  Yet these were the same people who would have to vote on approving the funds, and are facing re-election in a month.  Then the people at Treasury proceeded to argue about it when Congress tried to make changes.  If the people at Treasury really wanted to get things done quickly, a more middle-of-the-road proposal that recognized some of the political realities would have worked much better.

Educating the Public

Your average American (and Congressman) does not understand the workings of the credit markets and how it affects them personally.  The perception of the legislation was that the U.S. taxpayer was going to buy all of these distressed securities from the big, bad banks leaving the banks free and clear and the taxpayer with the bill.  The reality is far more complex.  Banks are required to mark their securities to market. When fear grabs the credit markets and securities can’t trade, marking to market results in a cascade of lowering valuations that feeds on itself and erodes banks’ capital position.  With eroding capital, banks can’t lend and the economy grinds to a halt, and everybody from Wall Street to Main Street suffers. Treasury should have made it clear that their role was similar to that of a specialist or market maker.  They were going to step in, provide a market for the securities, initially as a buyer, but eventually as a seller as well. Banks, in selling to Treasury are going to take a loss, albeit not as big of a loss as if there were no buyer.  The point that needed to be made to the public was that banks were going to suffer here, not get off Scott free, and the ultimate beneficiaries are all people that borrow from banks, which is pretty much everyone in the U.S.

Treasury is not subject to mark to market accounting rules and can wait until the markets return to a semblance of order before selling.  In all probability, Treasury will probably make money on these trades as they can afford to wait the market out.  We may not know exactly what these mortgage backed securities are worth, but they clearly are not worthless and probably worth more than panicky sellers will unload them for.  One of the axioms of Wall Street is that you can make a lot of money if you can afford to be patient during a crisis.  So the second big educational point that needed to be made was that the intervention into the markets by Treasury would eventually be to the benefit of the U. S. taxpayer.

You can argue that the folks at Treasury and the Federal Reserve were in crisis mode and not thinking about communications issues, but if you want to get things done in Washington, communicating the story in the right way is half the battle.

When Culture Meets Financial Theory

How often have you seen this: A company makes a big public announcement regarding a new strategic initiative designed to bring wiz-bang methods and profitability to the way the company does business.  Investors are intrigued because what the company has announced seems eminently reasonable and conforms to what the analysts were taught in business school. (Of course, the consultants that the company is using all went to the same business schools, so there is a bit of circular reasoning at work here, but leave that for another day.)  Following the initial splash of the announcement, investors clamor for more details on the big new initiative.  What they are usually greeted with are phrases such as “It’s still early days”, “It’s too soon to see anything out of this” or “This is a big project that touches many areas of the company and it’s very difficult to measure”.  Eventually, the amount of information about the project coming out of the company slows to a trickle and then stops.  In the noise of the market, investors forget about the project and look at other things.  No one ever really finds out if the project had an acceptable return on investment.

What’s going on here?  It’s not as if the company is no longer working at trying to implement the new project.  It’s not as if they don’t have internal measures that gauge the progress of the project.  If the news were great, would the company stay silent on the issue?  Maybe, but probably not - they would be much more likely to be trumpeting the triumph of new technology.  I would suggest that what is happening is the corporate version of a shell game: the company would prefer that you direct your attention to something else so they don’t have to explain why their vaunted project is not living up to it’s initial promise.

Large, radical new corporate initiatives almost always represent a break with existing corporate cultures.  I have a favorite saying about this situation: “When culture meets financial theory, culture almost always wins”.  The corporate culture in many organizations is part of the corporate DNA and will fight off attempts to change it.  The result is generally that the big new project will wind up costing more than initially planned, take longer than estimated and do less than the original projections.  When companies start to see this, they begin to build up a barrier around the project by limiting further disclosures.  I’ve seen this any number of times.  For example, during the 1980s Walgreen embarked on a “Strategic Inventory Initiative” designed, among other things, to lessen the amount of inventory carried in the stores.  Millions were spent on computer systems to help achieve optimal inventory levels.  Unfortunately, the culture of the Walgreens store managers was that they wanted their stores to look as if they had lots of inventory.  Their culture was to never to be out of a product if they could help it.  As a consequence, inventory levels never went down.  More recently, Home Depot went through a big reorganization to centralize many functions that had previously been done at the store level, running smack into a culture that had been centered around the store managers.  The result was a lot of dislocation and same store sales that were anemic for a protracted period of time. 

I’m not here to say that corporate cultures are always right – they’re not.  Many times corporate initiatives to change ingrained methods of doing business are both necessary and difficult.  But as I look at the way such projects are disclosed to investors, and the short-lived way that investors pay attention to the projects, I think things could be better.  Herewith, a few modest suggestions: For companies – if a project is important enough to announce to the public, it is important enough to continue to report about it until it reaches maturity.  Recognize that the project will vary from its original projections and provide sufficient metrics to enable investors to judge the progress of the project.  The ability for investors to determine if an adequate return is being achieved on the company’s investment seems to me to be a reasonable goal.  For investors – make the company continue to disclose.  Have a long-term outlook when it comes to this type of project.  Try to figure out how the project fits into the overall fabric of the corporation, not just whether it sounds like something your business school professors would recommend.  

Perhaps if corporations and investors take a longer tern view of these projects both sides will benefit – after all, more disclosure about things the company thinks are important should be better for investors as well.

How to Read 10K and 10Q Reports

The Annual and Quarterly Reports on Forms 10K and 10Q are documents that come under the heading, “Important, but boring”.  If you are an investor trying to read one of these things, it’s equivalent to drinking a glass of warm milk just before bedtime.  It’s guaranteed to induce drowsiness.  And that’s just the way companies want it.  These things are written by teams of accountants and lawyers, whose job it is to comply with the law and regulations set out by the SEC and the courts, while saying as little as possible.  While the SEC may mandate the use of “plain English”, there is no obligation to make the language interesting.  It is yet another example of the focus of our corporate disclosure system on complying with regulation rather than attempting to clearly state what is going on. 

Yet there’s lot of good information in there, if you can persist and find a way to dig it up.  The tricky bit is that often the interesting information is what’s changed from what they used to say or what is no longer being said.  And that’s hard to figure out.  If you are a sell side analyst who has intimate familiarity with the company filing the report, things that are not being said may instantly pop up at you, but for the rest of us, remembering what is not there, but should be, or what has been subtly changed, is a much more difficult task.  As I thought about this it occurred to me that these reports are rather lengthy documents, which no one could write from scratch every quarter.  What the writers of these documents do is take last year’s document from the same time period and mark it up for changes.  Certain things have to get changed – after all, the numbers aren’t going to stay the same every year; but other changes give you some insights into what the company may not be saying and how they view their disclosure obligations.

So the thing to do is to lay out this year’s and last year’s report side by side and work your way through the important sections.  Just to take an example, I looked at CVS, the large drugstore chain.  Picking a subject at random, I went to see how many pharmacists they have on staff, as it might be an important indicator of service levels.  Here’s what I found:

2007 10K

“As of December 29, 2007, we employed approximately 200,000 associates, which included more than 20,000 pharmacists…” 

In and of itself, this snippet of information doesn’t tell me a whole lot – if you combine it with the number of stores they had open at the end of the year, 6,301, you have a ratio of 3.17 pharmacists for every store.  So I laid it next to what they said the previous year:

2006 10K

“As of December 30, 2006, we employed approximately 176,000 associates; of which approximately 20,000 were pharmacists…”

Now things start to get interesting – did CVS really add 24,000 new employees but no net new pharmacists?  Or are they hiding behind the weasel words “more than 20,000” in 2007 versus “approximately 20,000” in 2006.  Further digging showed that CVS completed a big merger with Caremark in 2007, so they could have added a significant number of employees, but they also added 99 net new stores from 2006, so the ratio of pharmacists to stores fell from 3.22 in 2006 to 3.17 in 2007.  Just to maintain the same ratio of pharmacists to stores in 2007, CVS would have had to add 318 pharmacists.  Furthermore, the old Caremark was a pharmacy services provider, so presumably they had pharmacists on staff that transferred over to the new combined CVS. 

So what does this tell me as an investor about CVS?  It sure raises a lot of questions, none of which CVS tries real hard to answer in their filings, to wit:

1.  Did CVS reduce service hours and staffing for pharmacists in their stores?  Have they suddenly gotten more efficient?  Were 2006 staffing levels too high?

2. Is CVS having trouble hiring enough pharmacists?  This was an issue with them several years ago, causing a decline in earnings and should therefore be of interest to current investors.  It might even rise to the level of what an investor would consider important in making an investment decision about their stock.

3.  Why doesn’t CVS use exact numbers when describing how many pharmacists they employ? Can’t CVS be bothered?  Or is it that their systems aren’t good enough?  You would think they would have records and systems that tell them, especially at yearend.

4.  Does the use of weasel language such as “more than” and “approximately” about a key type of employee make you nervous?

5.  Where are all the pharmacists from Caremark?

6.  Should an investor start to look at other numbers CVS uses to see if they tie out?

The drafting of an Annual Report on Form 10K passes through many hands in a large corporation, from the internal accountants, internal securities law lawyer, investor relations personnel, outside securities law lawyers, the General Counsel, senior executives and the Disclosure Committee.  When you see a change such as the one above, you have to conclude that there was a deliberate choice to be vague on the topic and hope nobody would notice.

The Shifting Sands of Activist Investing

For about the past 6 – 7 years there has been a quiet revolution occurring in corporate governance. It has been an interesting process to watch as shareholders, usually led by union pension funds, have pushed for reforms in anti-takeover provisions, executive pay and director elections.  

The fact that it is the unions pushing for reform strikes me as ironic.  Regardless of how you feel about the need for collective bargaining, unions are not known as reforming forces.  Many union pension plans, in particular, have been grossly mismanaged, so for them to lead the charge for reform in corporate governance seems to be rich indeed.  When I gave this some thought, my conclusion was that a governance system has to be pretty broken for a group of union people to see an opportunity for reform.  So I took a hard look at the issues they chose to contest. 

Start with anti-takeover measures.  Companies usually experience a takeover bid in the form of an offer to purchase the company’s stock that is higher than the current stock price.  So anti-takeover measures, when all is said and done, are designed to allow management to turn down an offer that is higher than the current market price, but less than the managers think the company might be worth sometime in the future.  Presumably this is because the company managers know more about the company than the market and are in a better position to assess the true value of the company.  But wait, aren’t markets supposed to be efficient and incorporate all available information about a company into the stock price?  And aren’t managements supposed to disclose all material information about the firm to investors?  So anti-takeover measures really boil down to company management saying we want the ability to say no, because we believe that our two birds in the bush (the future value of the company) are worth more than the bird you have in hand (the takeover bid), because of information which we haven’t bothered to disclose, but which could make us real valuable in the future.  Sounds like a losing issue to me. 

Executive pay is an issue where corporations ceded the moral high ground a long time ago.  The pay packages you see for most CEOs of major corporations today are obscene.  The irony here is that the unions have persuaded Wall Street money managers, who often make almost as much as CEOs, to vote for reforms aimed at lower pay.  Maybe there’s a touch of envy involved. 

Finally, think about director elections.  I lived in Chicago for many years, so I’m not shocked by elections that are lopsided in favor of incumbents.  But under the current system for electing directors, you only need a single vote in favor of the director to get him elected.  You can’t vote against him, you can only withhold your vote.  This bears a strong resemblance to the old Soviet era politburo elections. 

If this were just about the obscure ways in which companies conduct their internal workings you could file this piece under important, but boring.  However, it seems that by allowing activists to learn how to win votes on easy issues, corporations are now starting to encounter a more sinister foe. 

According to a speech given by John Siemann of Laurel Hill Advisory Group at the NIRI 2008 Southwest Conference, hedge funds have become much more involved in the proxy activist arena.  ISS, the proxy advisory firm, now counts almost as many hedge funds as clients as it does union pension funds. For the hedge funds, the preferred method of attack is the “Short Slate” proxy fight, where an activist hedge fund nominates one or two directors for the board.  Once on the board, the new directors use their positions to agitate for items that may boost the near term stock price, such as special dividends, share repurchases and the sale or spin-off of non-core assets, at the expense of longer range initiatives.  According to Laurel Hill statistics, in 2006 – 2007, there were almost 200 short slate fights and in more than 66% of these situations, hedge funds won at least one seat on the board. Moreover, in almost 80% of the contests, ISS recommended in favor of at least one member of the dissident slate.  

So it would appear that having allowed the camel’s nose under the tent on issues that were hard to defend, corporations now find that they have provided a road map to investors to actively challenge the manner in which a corporation is being run.  I guess you really do reap what you sow.

What You Don’t Say Can Hurt You

Back when I was an attorney, I used to have to negotiate a fair number of documents.  When I was doing this, there was an unwritten rule that said that if you had the choice between drafting the document or reviewing it, you always elected to draft the document.  The reason for this was that in writing the document you could control what went in and what got left out.  The hardest thing in reviewing a document is figuring out what’s not in the document that should be there.  We always tend to focus on what’s said instead of what is not said. 

 

In the realm of investor relations, corporations start at an advantage over investors.  Corporations almost always control the flow of information, choosing what they will say and staying silent on many items that don’t favor them.  It then falls to investors to attempt to get the corporation to speak on those issues, if they are tuned in enough to realize that the corporation is staying silent.  Alternatively, investors can parse through oblique and obscure references contained in the company’s press releases, regulatory filings and other commentary to try and triangulate the data in order to figure out what’s going on.  Companies hate it when analysts do this and often claim the analyst has got the analysis wrong, but by trying to hide the data, companies get themselves into this pickle.

 

For example, let’s take a hypothetical example of a company that in a conference call talks about having “nearly 50,000 employees”.  Thinking this number sounds different, an analyst starts to dig back through records until he finds the next most recent reference to employee count, in a 10-K filing from a year ago, a reference to the company having 50,900 employees.  It would appear that the company has reduced their employee count by about 1,000 people over the course of the year, but have never mentioned layoffs, hiring freezes or reductions in force.  It may sound like a lot, something that the company should be forthcoming about, yet they have remained silent over the past year.  Have they fulfilled their obligation to disclose by the obscure reference to “nearly 50,000 employees”?  Maybe there is a good reason for the lower headcount – a facility or two may have been shut down or consolidated, more efficient operations, or something else, but the investors are purposely being kept in the dark, so the logical explanation is that the company is trying to hide something, and that something is bad news – layoffs and firings.

 

Now let’s have some more fun with this hypothetical and say that the company has recently opened a new distribution center in the last quarter, one of a series that is designed to change the manner that the company gets product to market.  But their quarterly press release doesn’t say anything about the new facility, which cost many millions of dollars, nor does it say anything about the remaining distribution centers to be built.  If an investor is savvy enough to notice this silence, how are they likely to interpret it?  That things are great, but the company just didn’t feel like talking about the project?  Possible, but not likely; it’s much more probable that an analyst will conclude that the company is hiding something they would rather not talk about.  Investors will assume that if the news was good, the company would naturally talk about it.  Even if the project is going great guns, the company, by remaining silent, puts a negative inference on it. 

 

Companies constantly accuse analysts and investors of having a short-term focus.  Yet companies themselves are extremely guilty of engaging in selective, short-term dissemination of information.  The process goes like this: “If it’s good news, we’re happy to talk about it until the cows come home.  If it’s bad news, you won’t hear a peep out of us unless someone is holding a gun to our heads and forcing us to disclose.”  In other words, good news is long term; bad news is short term.  I’ve written about this before in the context of Starbuck’s same –store sales; they didn’t stop disclosing them until they started to look weak. 

 

The investor relations profession needs to start thinking in terms of standards:  if something is important enough to talk about when the news is good, it is also important enough to talk about when the news is less than good.  If you have important projects or metrics by which you measure your business, then the only way to build credibility is to report on them when the news is both good and bad.  Silence is not golden.  It may be permissible within the cockamamie regulatory system we have, but it will not make the market more efficient, nor will it add to the long-term valuation of your firm.  

The Jumbled Mess Surrounding If and When to Disclose

Last week I wrote about the definition of materiality in the context of investor relations, and the case decisions wrestling with the concept.  When I boiled it all down, what I came up with is that an investor relations officer will determine something is material when, based on his experience dealing with investors who are interested in his company, he knows that the investors will think the information is important.  It’s not perfect, but it has the elegance of simplicity.  So now it’s time to take the next step on this slippery slope and ask ourselves; “OK, we know this information is material, now when do I have to disclose it?”  

On the face of it, this should be a simple problem.  Logic would dictate that if information is important, it should be disclosed as soon as possible, so that investors are not disadvantaged by the silence of the corporation.  If we had principle-based disclosure with continuous disclosure obligations on the part of the corporate issuers, this would be the case.  There would of course, be exceptions for sensitive issues such as merger negotiations, products under development, quarterly earnings and the like, but the general rule would be clear: Disclose as soon as possible.

Alas, we do not live in a world where the legalities surrounding investor relations are governed by logic.  We live in a world where investor relations is governed first, by statute, next by governmental regulation and third, by the case law arising out of the litigation caused by the first two.  The result is a jumbled mess when it comes to when the obligation to disclose begins and what happens thereafter.

In general, here’s how I understand all of this fits together.  (Note:  Although I am a lawyer, I am not your lawyer, and in writing this I am not expressing a legal opinion.  If this stuff is really important to you, get your own damn lawyer.)  The Securities Exchange Act of 1934 empowers the Securities and Exchange Commission (the “SEC”) to require companies to file periodic reports on their business, generally 10-Ks (annual) and 10-Qs (quarterly). These reports are designed to get companies to disclose all material information surrounding their companies.  Originally, if a material development occurred in between the filing of the periodic reports, a company had no obligation to disclose that development, but if they did choose to disclose it, they could do so on Form 8-K.  More recently, in 2004, the SEC came out with a release (SEC Releases Nos. 33-8400, 33-49424 (March 16, 2004)) that lists certain material events they deem so important they trigger the obligation to disclose on a form 8-K within four business days. These events include such things as entry into a material non-ordinary course agreement, departure of directors and officers, material impairments and many others. The list is lengthy, but not exhaustive.  So, if your company has a material development in between your periodic reporting cycle, and it’s not on the list, you may choose to remain silent on it, provided the company is not actively buying or selling the company’s securities. 

Not only may you choose to remain silent to the detriment of your investors, the regulatory and case law decisions push you in that direction, because once you say something, the anti-fraud provisions of Rule 10b-5 attach and you’ve got to be absolutely correct or you’ll get sued.  This might be difficult to do initially in situations where things are unfolding and you are uncertain of the magnitude.  Next, if you do say something, you will trigger a duty to correct in the event facts change, as they almost certainly will, and may also create a duty to update the information in the future.  Lawyers, who’s job it is to mitigate their client’s risks, will therefore almost always advise their clients to say nothing, and if you do have to say something, say as little as possible.  If fully informed investors lead to the most efficient markets, can this be good for the markets?

Let’s just take a hypothetical case.  Say you had a charismatic chairman who not only was the public face of the corporation, but was also viewed as having saved the company from ruin.  Let’s call him Steve Jobs.  The chairman, who has previously had a bout with cancer, makes a public appearance and looks like death warmed over, triggering speculation about his health.  Clearly, it’s something investors think is important, based on their reactions and questions.  The health of the chairman is not something the SEC has thought to put on its list of things that have to be disclosed within 4 business days.  The company could stay silent on it, triggering massive speculation.  Instead, a company spokesman states that the chairman had picked up a “common bug”.  Presumably the statement is correct, since if they knowingly made a misleading statement they would have violated the antifraud provisions of Rule 10b-5 and at some point they wil get the bejesus sued out of them.  Now however, they are saddled with a duty to correct, should things turn out differently and potentially, a duty to update.  And how long do these duties last?  This reminds me of the tar baby situation from Uncle Remus.  No wonder companies don’t want to say anything if they don’t have to.  (For a more complete, lawyer-like analysis of this situation, see Brock Romanek’s July 25^th post on the Corporate Counsel blog, link listed on the side.)

Which leads me back to what common sense tells me the underlying principle should be:  If it’s important, a company should disclose it as soon as possible, and continue to disclose as events unfold, except in very specific and narrow situations.  At the end of the day, the principle should be biased to favor the flow of information to investors, not to create additional liability and obligations if you do disclose. 

Materiality and the Little Voice in Your Head

Sailors have a saying: “The time to take a reef in your sails is the first time you think about it.”  What they mean by this is that it is if you think the wind is getting stronger, you are much better off shortening your sails now, before you are overpowered by the wind and the act of reefing becomes very difficult, if not dangerous.  There is a similar analogy that can be made with respect to whether you think a piece of information is material and should be disclosed. That is, if you have to stop and think about whether something is material, it probably is.  Or, to complete the analogy, the time to disclose information is the first time you think about whether it is material. 

 

I know that this goes against the grain of most corporate disclosure policies, which seem to be, “The time to disclose information is when we absolutely, positively have to, and can find no reason to hide behind, and can’t convince our lawyers that this really isn’t as important as it sounds.”  Nor is the legal profession without blemish in this regard.  There is a corollary, unwritten rule which seems to be, “If the Chairman doesn’t think something is material because he really doesn’t want to talk about it, (or he has goofed and let something slip, but now doesn’t want egg on his face by having to make a formal announcement) the General Counsel and outside attorneys will find a way to justify the information not being material. So I thought I would take a moment and wade into the legal thicket of what information is material. In a later post I will discuss when you should, as opposed to must, disclose material information.

 

The classic definition of what constitutes material information was set out by the United States Supreme Court in two cases, TSC Industries, Inc. v. Northway and Basic v. Levinson.  The pertinent language of the court was contained in two statements:  “Information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision.” And “There must be a substantial likelihood that the disclosure of an omitted fact would have been viewed by the reasonable investor as having significantly altered the “total” mix of information made available.”

 

This seems relatively straightforward to me, as most of us can put ourselves in the shoes of a reasonable investor, and there is no mention in the Court’s language about the information being either positive or negative – it just has to be important.  Nevertheless, countless billable hours of lawyers’ time has been spent on this issue, which, when you think about it, is pretty silly.  Investor relations officers spent most of their time talking to – you guessed it – investors.  Who better to know what the reasonable investor considers important?  Yet we constantly have lawyers and accountants weighing in on the subject, even though none of them would know an investor if they ran into one.  Does this make sense?

The practice of investor relations involves a high degree of repetition in answering investors’ questions.  It doesn’t take long for an investor relations officer to get a pretty good feel for what investors consider important (of course, there are some analysts who think everything is important, but they, by definition, are not reasonable investors).    Therefore, as a corollary to the Supreme Court’s guidelines, allow me to propose another one of Palizza’s Principles: Something is material if the little voice in your head (or, if you prefer, your gut) tells you that investors would think this is important information. It seems to me that this is no less obscure than the language often used by the Supreme Court.  After all, it was Supreme Court Justice Potter Stewart who was famous for stating; “[I can’t define obscenity, but] I know it when I see it”.

The Trouble With PowerPoint

There was an old Star Trek episode, "The Trouble with Tribbles".  Without going into all of the details of the plot, suffice it to say that tribbles, which are adorable, cuddly creatures, when brought on board Captain Kirk's vessel, reproduce far too often and threaten to consume all of the supplies on the starship Enterprise. So it is with PowerPoint.  It's a (relatively) easy program to use and enables almost anyone to become a designer of graphic presentations. In fact, graphic designs proliferate to the point of threatening to consume all of the useful information in investor relations presentations.

I’ve spent some time lately poking around on the web looking at various companies’ investor relations presentations.  I have not been impressed.  Just about every presentation I looked at had something in it that bothered me. The combination of PowerPoint bullet point formats with bad graphics can be really deadly to good communications.  It’s clear to me that investor relations practitioners are better at verbal communication than visual communication, so I thought that I would share some of my thoughts on the subject. 

Let me start out by saying that I have a bias when it comes to presentations – the presentation should enhance and clarify the data, not distract from it.  To understand how good presentations can work and what constitutes bad display of data, every person that has to make or prepare a presentation should read Edward Tufte’s book, “The Visual Display of Quantitative Information”.  It is the seminal work in this area and it sets out with much greater authority and detail than I can the elements of good data presentation.

Having said that, here are some of the chief complaints I have about the presentations I’ve reviewed:

1.  Cheesy backgrounds – just because PowerPoint gives you all sorts of ugly templates to choose from doesn’t mean that you have to use them.  All they do is distract from the message you are trying to deliver.  My advice is to hire a professional design group to help you set a template, which ties into your corporate design or this year’s annual report.

2.  Runaway fonts – it is not unusual to see five or six different fonts and type sizes on the same slide.  This is sloppy and distracting.  This is a particularly egregious sin of PowerPoint, which will automatically resize type on slides unless you take out a whip and chair and tame it.

3.  Use of acronyms and abbreviations – Corporate America loves TLAs (three letter acronyms).  Unfortunately, while they may be a handy shorthand for those in the know, when encountered later, on a slide on the company’s investor relations website without accompanying commentary, they merely serve to obscure things.

The foregoing, while distracting, are design errors, and can be forgiven as simply in bad taste.  In the parlance of my religious upbringing, they are venial sins, as they don’t really bring into question the integrity of the presenting company. However, some of the things I’m going to talk about now are issues where the visual information is manipulated to make data appear more favorable than it really is, which is something no self respecting investor relations practitioner should stand for. 

4.  Using objects that grow in volume to show linear growth.  Unfortunately, we’ve all seen this one far too many times.  Using pictures to show the growth of say, revenue, introduces a distorting factor as the volume of the object depicted grows much faster than the growth of a linear object such as money.   If you have to jazz up your charts with cute pictures or expanding objects, you probably don’t have enough data for a chart.

5.  Conveniently changing scales on charts to make data appear to fit your point.  Not all charts and graphs need be zero based, but you need to be careful about the scale you use.  It is far too easy to manipulate the visual impact of change by zooming in on a scale, which makes a single percentage point change seem huge.  A corollary to this is changing scales on two adjacent charts to make it appear as if everything is moving in the same magnitude and direction simultaneously.

6. Omitting inconvenient data.  I find it hard to believe that companies would do this, but I’ve seen it with my own eyes.  If a particular year doesn’t fit the fact pattern that companies wish to talk about, they simply omit the data from the chart.  I guess they think that no one will notice the year missing from the bar chart.  A different take on this is to put the inconvenient data on the chart but then assert in words that something different and more favorable is going on.  My favorite example of this is a chart that shows a large dip in earnings in a recent year with an arrow going right past it stating “Continuous growth”.  Last time I looked, continuous meant without interruption, which clearly wasn’t the case for the earnings growth shown on the slide. 

There are more examples of bad and misleading graphics out there, but I think I’ve made my point.  Besides, I have to prepare some slides for a speech I’m giving at the NIRI Southwest Regional Conference next month and if I can just get the dancing 3-D graphics to work, it could be a real triumph of form over substance.

More on Blogging and Investor Relations

There are over 2,200 stocks listed on the NYSE and over 3,000 stocks listed on NASDAQ and guess how many have blogs for their investor relations areas?  The answer is one – Dell Shares is the only corporate investor relations blog that I have been able to find.  I think that the fact there is only one blog in this area (you can find blogs in other areas, be it CEOs, sales or product teams, etc) is indicative of the mindset most corporations have about investor relations.  In most organizations, IR is trapped in a box of regulations and legal liability. Moving outside the box requires more time, effort and political capital than it’s worth.  For example, in one organization where I previously worked, it took a year of lobbying to get the concept of quarterly earnings conference calls approved.  Once approved, the scripts for the calls were reviewed by the CEO, COO, CFO, Controller, General Counsel, securities law counsel, outside securities law counsel, Treasurer, internal auditor, external auditors and at least 6 other people.  Needless to say, by the time the final document was ready, it was pretty bland mush.  Try thinking about how blogs translate into this type of environment and you see why most companies don’t even try.  Blogs are supposed to be quick, spontaneous and resonate with the voice of the writer.  Good luck to that under the foregoing scenario.

Evidently Dell takes seriously its image as a technology provider and is out in front on this development.  I’ve spent some time over the past few days looking at their blog and I think they do some things well.  First, they are timely and responsive.  They seem to write about developments quickly and respond to comments rapidly.  According to a statement made by a Dell spokesman at the 2008 NIRI conference, their position is that in establishing a blog they did not need to change their disclosure policy or get prior approval of each posting from their legal department.  Rather, their view is that the blog is merely another extension of what they do everyday in investor relations, either on the telephone or in person.  They are aware of the things that can and cannot be said and in writing on the blog simply adhere to the same guidelines as they would in other channels of communication.

The communications person in me cheers this attitude.  Phrases such as “IR workers of the world unite!  You have nothing to lose but your lawyers!” run through my brain.  Of course, having practiced law for ten years, the other half of my brain says “Yeah, but if you screw up with an analyst on a phone call you always have the chance to call him back and correct yourself, or, if you’ve inadvertently given them non-public information, to ask him to treat what you’ve said as confidential.  When it’s on the world wide web, it goes out to the whole world and you’ve created a written record of your mistake.”  I guess all technological advances come with attendant risks. 

Secondly, I think Dell is bringing more information to a wider audience.  They refer to this as a democratizing of investor information and I certainly think they are moving in the right direction.  They have made video clips available on the blog with members of management discussing some of their more obscure business initiatives (what the heck is virtualization anyway?).  All of this helps to gets information, which before was available only to large institutional investors out to a wider audience. This is one of the major benefits of the web.  Business school professors refer to this as disintermediation.  To put it plainly, you get your information direct from the source, and not filtered through others.  I applaud them in their efforts to date to get information out to a wider group of investors.

Naturally, in my self-appointed role of investor relations critic at large, there are several things that I think they might be able to do better.  First, in reading the blog, I didn’t get a real sense of Dell as an organization.  I think that Dell has a tremendous opportunity through its blog, to put a human face on a highly complex organization.  Thus far, the posts to the blog have been governed by the issue du jure without any effort that I can make out to explain the organization as a whole, which I think would be helpful to the average investor visiting the blog.  Turns out there is a good introduction to Dell on the Investor Relations web site in the form of an interactive letter to shareholders from Michael Dell, but it required navigating back to the Dell home page and three further clicks to get to the letter.  It seems strange to me that there is no direct link between Dell Shares and the IR web site, as there is a link going the other way. 

Related to this I think that Dell has an opportunity to save themselves a great deal of repetition and time by creating a series of explanatory blogs about the areas of their business that generate the most questions from investors.  I see the beginnings of some of this with the video clips with interviews of business segment managers, but as they are a very large and complex organization, more can be done. 

Next, as you might expect, everyone is relentlessly on message in their posts.  I can understand why this is, but it can make for some bland reading.  If I were an equity analyst, the blog is not where I’d go to try and find any nuggets of information, although it would be required reading.  Maybe it would help if someone would exhibit a sense of humor once in a while. 

To a certain extent, I’m picking nit with all of this.  Dell deserves a lot of credit for establishing their blog.  In tech-speak, they have achieved first mover status.  While I believe that good things will accrue to them as a result, as with many things in investor relations, it may be hard to measure, and probably only in retrospect.

The Ten Percent Rule

Previously, I’ve written about the research surrounding the value of investor relations.  This is a question that constantly bedevils investor relations officers, as senior management, used to seeing quantifiable numbers such as increase in sales, Return on Capital and Return on Assets wants to know their ROIR (Return On Investor Relations).  Put bluntly, they want to know, other than frequent flier miles, what does their company get for the time and effort expended going to visit investors and enduring the often repetitious and sometimes inane questions from analysts who are young enough to be the Chairman’s grandchild?  Unfortunately, it is very difficult to separate the IR performance alpha from the firm’s performance beta or the general market performance (I’m going to resist the impulse to assign a variable to market performance, otherwise this would be all Greek to me).  It’s an intellectually challenging question, so I find myself returning to it time and time again.

There’s some interesting new research out, which I will get to in a minute, but first, just to refresh readers, what I’ve found so far is as follows:

Rivel Research has conducted two studies that touch on this area and are worth repeating.  In their study, “Perspectives on the Buy Side”, conducted during the Spring of 2007, Rivel conducted 243 interviews with Buy side analysts and portfolio managers.  As part of their study, they asked the question: “In your opinion, does good investor relations affect a company’s valuation?”  82% of the respondents to the question answered Yes, while 17% said No.  Further, the median premium assigned by the respondents for “superb IR” was 10%, while the median discount for “poor IR” was 15%.  In a companion study performed later in 2007, “Perceptions on the Sell Side”, the numbers were strikingly similar, with the median premium assigned for “superb IR” again being 10%, the discount for “poor IR”, 18% and 82% of all interviewed Sell Side analysts expressing the opinion that good investor relations helps a company’s valuation.  If you want to read more on this topic, see my post dated August 20, 2007.

I’ve also written about what the academic research has shown regarding investor relations.  In my March 13, 2008 post I talk about the effects that improvements in disclosure quality and quantity have been shown to have on liquidity, bid-ask spreads, volatility, and risk assessments of the firm.  While these studies have been illuminating, there hasn’t been a study that establishes a direct linkage between good investor relations and increased market valuation.  The studies have generally focused on one or two aspects and required you to make the logical inference that the result is better stock valuation.  Additionally, one tricky bit has been to identify who is doing “Good” investor relations so you can measure them against the average.  Now a study has done just that.

Professor Richard J. Taffler of The Management School, University of Edinburgh, together with Vineet Agerwal, Angel Liao and Elly A. Nash have authored a study entitled “The Impact of Effective Investor Relations on Market Value” that every investor relations officer should read.  In their study they use IR Magazine’s “Best Overall Investor Relations” awards over a three-year period as an indicator of quality investor relations.  Their study shows that firms that are seen as having effective investor relations, as indicated by being nominated for the awards, earn superior abnormal market returns both in the year of nomination and the year following the awards. 

The authors state that while superior market returns for stocks could be explained for the year prior to the nomination by analysts nominating firms which had performed well, this cannot explain the superior market returns for the companies in the year following their nomination for an award.  To quote the report: “Consistent with the predictions of information risk and agency theories, which together propose that enhanced corporate communications will reduce information risk or agency problems caused by high information asymmetry, we find that [IR Award] nominated firms experience an increase in stock liquidity, and a lower cost of equity capital.” In other words, companies that do investor relations well, as witnessed by nomination for Best Overall IR awards, are rewarded with better stock price performance and stock liquidity.

Of even more interest is the quantification the authors put on the abnormal risk adjusted stock returns earned by firms in the year following their nomination for an award.  The results show that all nominated companies earned 80 basis points per month superior market returns.  When I pull out my trusty Hewlett-Packard and compound 80 basis points per month over a full year, I get an excess return of 10%.

Based on the foregoing, I hereby propose Palizza’s First Principle of Investor Relations:  Superb investor relations will gain a 10% premium for your company’s stock price.  This rule satisfies my three main criteria for a principles:  1. It’s easy to remember, 2. It involves a nice, round number, and 3. It has at least 3 data points to support it.

Every investor relations officer should get a copy of Professor Taffler’s study and show it to their management, especially around budget time.  A relatively small increase in investor relations budgets coupled with increased transparency and disclosure above and beyond what is required by regulations can pay handsome dividends for shareholders.