Friday, January 30, 2009

Walgreens’ CEO – An Inside Job

I have a confession to make.  There is software on this blog that allows me to see statistics about what posts are most popular, where my readers are coming from and how they get here.  I can’t tell down to the exact reader, but because I can see what networks the readers are using and the geographic region they’re coming from, so I get a pretty good idea of who my readers are.  And, much like the authors that check their Amazon book sales rankings, I confess that I regularly check my statistics with great interest to see if anyone is reading this stuff.

I’ve been surprised to find that the post I wrote about the firing of Walgreens’ CEO “Why Not Just Tell Us Why You Fired Him?” continues to be among the top visited posts four months after it was written.  Also surprising to me is that people using the Walgreens network have been among my most frequent visitors over the last month.  So, even though I haven’t worked for Walgreens for ten years, hello out there to all you Walgreens people, it’s nice to be remembered.  Of course, I’m not sure you remember me quite so fondly as I would like in light of some of the things I’ve written, but hang on, I’m about to say some positive things.

Earlier this week Walgreens announced that it was appointing Greg Wasson, its President and COO to the post of CEO following a search to replace their former CEO, who was “retired” last October.  This announcement was followed by catcalls from a number of sell side analysts that follow the company.  The received wisdom of the Street seems to be that Walgreens needs a new perspective, which an insider can’t bring. 

So my question for them is: “What sort of a fresh perspective do they expect an outsider to bring?”  One like Bob Nardelli brought to Home Depot?  Or one like Larry Johnston brought to Albertson’s? Or that Carly Fiorina brought to Hewlett-Packard?  I could go on, but I think you get my point.  Bringing in an outsider to run a company is tricky, and it’s even trickier when the company has a strong culture, as Walgreens does. 

Further, and this seems to be the elephant in the room that nobody’s talking about, Walgreens has an installed base of over 6,500 drugstores.  And those drugstores are performing pretty well, thank you very much.  Not as well as they used to, but better than 90% of all retailers in today’s environment.  So you don’t want someone to come in there and muck it up.  And, no matter what you do, short of a merger with a company equal in size and profitability, (and good luck finding one of those these days) the drugstores are going to be the engine that drives the train of profitability for Walgreens for a long time to come.  All this other stuff that is going on with the drug store/healthcare arena – clinics, specialty pharmacy, home infusion and the like, is at the margin.  It all sounds great, but the sales base in the drugstores is at least $55 billion and it takes a pretty good shift in segment sales to make a dent in the overwhelming weight of the drugstores.  In other words, you better have someone who understands drugstores running the show because they’re going to be what pays the freight, even if you elect to pursue a Boston Consulting type strategy where the drugstores are run as the “Cash Cows” of the business.  And that’s what makes Wasson, an insider, the right choice for the CEO job.  Nobody runs drugstores better than Walgreens does, but in retailing, if you take your eye off the ball, things can spin out of control in a hurry.

Walgreens closest rival, CVS drugstores, recently announced that it was lowering its guidance for next year’s earnings to an expected increase of 4.5%.  The reason given for the disappointing guidance was weakness in the pharmacy benefits management business, which just happened to be their big strategic acquisition (Caremark) of a couple of years ago.  The stock price performance for Walgreens and CVS has been similar over the past year, with both stocks losing between 20% - 25%. Yet I don’t hear any sell side analysts calling for an outside CEO at CVS.  I guess you get more credit with some Wall Street analysts if you go for big “game-changing” acquisitions than if you undertake to do things in a prudent and reasoned manner.

I’ll end by reiterating something I’ve written before:  Wall Street analysts are lousy at strategy.  Walgreens’ Board should be congratulated on keeping their heads when analysts were shouting for an outsider.  It’s rare that a knight can ride in on a charger and fix things with a wave of Excalibur.  More often, it takes someone who knows the system, can work with the culture to implement gradual change and is willing to make the hard decisions.  It’s very early days yet, but it appears that Wasson has a better chance to do that than an outsider would.

Wednesday, January 28, 2009

XBRL – What Is This Stuff?

I don’t think of myself as a Luddite.  In fact, for someone with as much grey hair as I have, I think of myself as pretty tech savvy.  After all, I have a blog, I also have my own web site, I carry around a Blackberry and I spend much of my day in front of a computer.  But, I have to confess, when it comes to XBRL as it relates to investor relations, I’m lost.  I’ve been to presentations at NIRI conferences where I hear speakers expound upon their theory that XBRL will revolutionize the way we look at and use financial data.  I hear them extol the virtues of how the information will be tagged and prepared for automatic comparisons and I wind up more confused at the end of the speech then when I started listening to them.  I find that when people start talking about XBRL, it’s similar to when I listen to computer programmers – I’m pretty sure they’re talking English, but not in a way that I can comprehend.

Finally, I couldn’t stand it anymore and I decided to try and figure out how all of this will affect me.  So I went out and did a Google search on XBRL (I told you I was half-way tech savvy, didn’t I?)  Here’s what I found:

“XBRL, like XML, applies identifying tags to items of data, which allows them to be processed and analyzed. Like XML, XBRL is a language intended to be read by computers, not humans. The use of XBRL tags enables the automated processing of financial data by specialized computer software, which eliminates the need for the tedious and costly process of manual re-entry and comparison. Once data has been tagged, computer software, rather than human labor, is used to select, analyze, store and exchange information. Moreover, since it is a standardized language, XBRL enables an apples-to-apples comparison across multiple companies and multiple industries.” 

So as I understand it, we’re going to be able to grab all sorts of data and the computer will tell us if the information is comparable.  If it is, then we can drop it into spreadsheets and unlock all that hidden information.  Leaving aside the issue of whether or not companies will code everything in the same manner (which is a pretty big issue by itself), as I see it, there are two potential problems here.  First, the numbers that are being tagged by XBRL are being prepared by humans using accounting.  As we all know, accounting involves a multitude of judgments.  Things that seem straightforward on the surface, such as revenue, can actually be quite tricky when you start to adjust for accrual accounting with its accrued revenues, deferred revenues, advances, long-term contracts and exceptions.  The tagging for XBRL will follow the accounting judgments, so unless all companies start to account for things exactly the same, discrepancies will crop up in the numbers.  In my experience, every company has certain accounting items that they handle differently from other companies.  The reasons for this range from “We’ve always prepared it that way” to “The system can’t handle it that way” to a variety of other excuses, but I assure you these exceptions exist.  Unless you get uniformity, comparisons are an illusion. 

Second, and this goes back to something I learned when I was taught math (or as we used to call it in those days, arithmetic), you can’t just read the problem and say, “I understand it”.  You have to get out your pencil and paper and work the problem to absorb what’s happening.  Maybe I’m a dinosaur, but when I’m examining a company’s earnings report, I pull out a calculator and work out the relevant ratios and changes I care about.  That way, as I work my way through the financial statement, I find I have a better understanding of where the variances are.  Maybe the next generation will be better at letting machines point out these things, but having helped three children learn math, I don’t think so.  

So as I understand it, XBRL will allow people to use software to manipulate numbers easier and faster (because they’re already tagged) for purposes of analysis and comparison.  There is, of course, no guarantee that the analysis will be any better understood or that the comparisons will be meaningful, but hey, you’ve got to start somewhere.

Sounds to me as if the XBRL revolution is being oversold.


Thursday, January 22, 2009

A One – Handed Economist

Harry Truman famously complained that what he needed was a one-handed economist, as all of the economists that were advising him would state “On the one hand… but then again, on the other hand…”  Old Harry S. can now rest easy in his grave, because yesterday I may have heard a one-handed economist.  

The occasion was my local NIRI chapter luncheon for January where we were treated to an economic outlook and forecast by an economist for an investment bank.  As you might imagine, given the current economic environment, the overall message the speaker was giving out was not overly optimistic.  I’m not going to depress you by going over all of the gory details, but there was one statement that caught my attention.  Speaking to the actions of the government and the Federal Reserve to combat the current economic downturn and credit crisis, he said, “They’re doing all the right things”.  That is about as straightforward a statement as you will ever hear from an economist.  This guy obviously did not take elocution lessons from Alan Greenspan.  

Naturally, when I heard something that simple and direct I got to thinking about it and I realized that there were a number of unstated assumptions in what had been said.  What I think the economist was really saying was, “[In my opinion, if this economic situation is similar to what we have experienced in the past, then] they’re doing all the right things.”  Of course, therein lies the catch – things are never quite what we’ve experienced in the past.  The financial markets that have evolved in the last ten years with Collateralized Debt Obligations, Mortgage Backed Securities, highly leveraged hedge funds and derivative markets are vastly more complex than anything that existed during any past financial crisis, be it the Great Depression, the Saving and Loan debacle or the Japanese economic bubble.  In each of these past downturns, policy makers thought they were doing the right things, but it’s only in retrospect that you know if they got it right or screwed up royally, because every time it looks the same, but it’s different. 

Which brings me to what we do in investor relations. (You knew I had to get here eventually, right?)  We are often confronted with situations that sort of look like what we’ve seen in the past, but things have changed.  Say you are going to make a presentation to an investor conference that you presented at last year.  You’re still the same company; the investors attending the conference are likely to be very similar to the investors that attended last year.  Things look pretty similar  - should you just mark up last year’s presentation and let it go at that?  Maybe, but are you really the same company you were last year?  Have your markets changed?  Perhaps you’ve gone from being a growth company to a value play.  Certainly your investors this year are not the same as they were last year as the market downturn has radically altered their view of the world.  Even if your company’s basic long term strategy hasn’t changed, it is probably time to think about a fresh approach to how you communicate your story to investors, taking the new reality into account. 

The same can be said for any number of situations we face in investor relations.  Should we be rethinking our approach to regulatory disclosure issues with the SEC smarting from some of its recent oversight failures?  Will non-governmental organizations and social activists gain more traction on proxy proposals with a more liberal administration and Congress in charge?  Are activist hedge funds relevant if access to capital is restricted?  We’ve seen all these issues before – interpretation of SEC regulations, proxy proposals, activist hedge funds – but not in the current environment.  History may be a help, but it is not a definitive guide.  You still have to bring judgment and critical thinking in order to weigh the issues and come up with a well thought out course of action because things are never exactly the same. 

There are more examples I could cite,  but I have to stop now – both my hands have gotten tired from all this shifting of issues back and forth.

Thursday, January 15, 2009

Maybe Things Were Not So Simple and Straightforward...

Apple seems to be providing a lot of grist for my mill lately.  I really don’t want to pick on Apple – I love their products.  This blog post is being written on one of four Macs my family owns, we have any number of iPods in the house and one of my kids even has an iPhone.  You would have to drag me kicking and screaming back into a Windows/PC environment.  Sadly, Apple, which is famous for its secretive corporate culture, looks as if it will have to be dragged kicking and screaming into good disclosure practices. 

Last week, I wrote about the situation at Apple with Steve jobs – see the post dated January 6, 2009, “The Weighty Issue at Apple”.  Earlier today, acknowledging that “my health-related issues are more complex than I originally thought” Steve Jobs announced that he was taking a medical leave of absence until the end of June 2009.  This announcement is the latest in a string of vague statements surrounding the health of the CEO of Apple.  First, there was the announcement in 1994 that he was “cured” of pancreatic cancer following a nine month period in which they concealed the fact that he was suffering from cancer.  Then four years later, following an appearance where he looked like death warmed over, a company spokesperson declared that he was suffering from “a common bug”.  Last week, following more rumors and a drop in the stock price, the story was that he was suffering from “a hormone imbalance” that was robbing his body of proteins, but we were assured that “”The remedy for this nutritional problem is relatively simple and straightforward…”  

If you are an Apple investor, you have to be really frustrated by all of this.  At this point you would think that Apple would have figured out that investors think the health of their CEO is very important to the future course of Apple (what a securities lawyer might call “material”).  Just look at what happens to the stock price every time there is a rumor about Steve Jobs’ health.  While I don’t like advocating looking in the rear view mirror to determine if something is material, plaintiffs’ lawyers do it all the time, so it’s a necessary evil.  The Apple statements thus far have only served to feed the continuance of rumors.  When I look at what they’ve said so far I come to the conclusion that they are either: 1. In denial, 2. Just don’t know, 3. Are staying relentlessly on message to protect the chairman, or, 4. Are doing what the Chairman wants in order to preserve a continuing stream of paychecks.  

I come back to what I wrote last week, which is that early and full disclosure, as distasteful and intrusive on the CEO’s privacy as it may be, is better for the company in the long run in terms of establishing and maintaining credibility.  So far, Apple’s credibility on this issue is extremely low.  So low in fact, that you might even say that it carries no weight.

Tuesday, January 6, 2009

The Weighty Issue at Apple

In an interesting investor relations development Monday, Apple CEO Steve Jobs announced that he is suffering from hormone imbalance, causing him to lose weight.  Now, you may ask, “Why is an announcement about someone’s weight loss important from an investor relations standpoint?”  There are a number of answers to that question, but the short one is that this is the first time Steve Jobs and Apple have taken a straightforward approach to the disclosure of his health as it may affect the company.  Of course, it may be that in light of their lack of candor in handling the issue in the past, this may be too little, too late, but that remains to be seen. 

Many companies take the approach that the health of their employees is a private matter, whether that employee is a clerk or the company CEO.  Certainly, if you take the position that all employees are interchangeable parts of the whole, and the illness or death of one will not have a material impact on the operations of the company, this would make sense.  Of course, it’s a bit less defensible if the CEO is making millions of dollars.  It seems to me that when companies grant executives huge compensation packages they are admitting that the loss or incapacitation of that employee will have a material adverse impact on the firm.  Presumably companies expect to get a return on their investment in their employees, so if the CEO is making millions of dollars, the loss of the CEO will result in the loss to the firm of at least that much, if not more, in firm earnings.  It’s even less defensible when, as is the case with Steve Jobs, the CEO is widely credited with personally turning around the company. 

Be that as it may, there is no SEC rule requiring that a company disclose or discuss the health of its CEO.   On the other hand, there is no right to privacy under the federal disclosure laws and regulations.  The SEC regularly requires company executives to disclose such personal information as compensation, perks, the purchase, sale and holdings of company stock and company dealings with family members, among other things. What investors must rely upon regarding CEO health is the general rule regarding disclosure of material events, which is to say, “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.”

So let’s look at how the facts apply to the relevant rule.  Several years back, in October of 2003, Steve Jobs was diagnosed with pancreatic cancer.  The company did not disclose the illness at the time, and Mr. Jobs was one of the fortunate few that contract a curable form of pancreatic cancer.  Jobs elected not to immediately undergo surgery for the removal of the tumor, instead trying to cure the tumor through a special diet.  After nine months of staying silent, Jobs finally underwent the surgery and only then announces that he had been suffering from cancer, but now he was “cured”.  So the first investor relations question that comes up is whether Apple acted properly is staying silent for so long.  I am willing to bet that a whole slew of lawyers working for Apple, including the company’s securities law lawyer, the general counsel, outside securities law firm and possibly even special counsel for the Board of Directors, looked at this question.  And what a surprise, they came to the conclusion that the chairman wanted. 

It seems to me that it would have been difficult for Apple to maintain that the possible incapacitation of their CEO was not a material event, especially in light of the statement concerning “Factors That May Affect Future Results and Financial Condition” on page 49 of their Fiscal Year 2003 Report on Form 10K (filed in December, 2003, after Jobs had been diagnosed with cancer), which stated “Much of the future success of the Company depends on the continued service and availability of skilled personnel, including its Chief Executive Officer…”  The only way Apple could have justified not disclosing the illness at that time was the line of reasoning first set out in SEC vs. Texas Gulf Sulphur Co. that because Jobs was still waiting to see how the cancer was responding to treatment, the issue was not yet ripe for disclosure.  Conveniently, the issue then became ripe for disclosure once Jobs was “cured”.

In part because of the way the original illness was disclosed, compounded by the secrecy that surrounds everything Apple does, the issue has refused to go away.  This past summer, four years later, Steve Jobs made a speech at an Apple technical conference, introducing the Apple 3G iPhone. He appeared noticeably thinner and speculation ensued that he was having a recurrence of his cancer.  In response to questions, an Apple company spokeswoman said Jobs had been hit by a “common bug” and was now on the mend with the aid of antibiotics.  In spite of this, rumors surrounding Jobs’ health have continued to circulate throughout the remainder of 2008.  

In December 2008, Apple announced that Steve Jobs would not be making a keynote address at the annual Macworld conference in January 2009, a speech that he had customarily given in the past.  Speculation and rumors concerning the state of Jobs’ health immediately increased and the stock dropped 10%.  On January 5, 2009, Apple released a letter from Steve Jobs to the public. In the letter Jobs states:

“I have been losing weight throughout 2008.  The reason has been a mystery to me and my doctors.

…Fortunately, after further testing, my doctors think they have found the cause – a hormone imbalance that has been “robbing” me of the proteins my body needs to be healthy.

The remedy for this nutritional problem is relatively simple and straightforward and I have already begun treatment”. 

The problem here is that in making the most recent statement, Jobs seems to be contradicting the Apple spokeswoman’s “common bug” statement of last summer.  If the reason for his weight loss was a mystery to his doctors, it could not have been a common bug.  So why should investors believe Apple this time?  Further, in terms of information content, there is not a lot of substantive information for investors.  One doctor interviewed by the Wall Street Journal has been quoted as saying “To an endocrinologist, the most vague statement you can ever make is the term ‘hormone imbalance’”. 

The investor relations conclusion I draw from all of this is that early and full disclosure, as distasteful and intrusive on privacy as it may be, is better for the company in the long run in terms of establishing and maintaining credibility.  If Apple had come out soon after the initial diagnosis of cancer in Steve Jobs they could have engendered tremendous sympathy and good will.  A continuing stream of disclosures could have kept rumor and speculation to a minimum.  Yes, the stock would gyrate, but the gyrations would be based on credible information, not rumor and innuendo.  I think that if you are the highly visible CEO of a publicly traded company, your privacy takes a back seat to the information needs of investors.