Tuesday, February 24, 2009

A “Cultured” Approach to Investor Relations

Last week I had the pleasure of going up to Columbia Business School and giving a talk to some of the second year finance students about a case I helped Professor Laurie Hodrick write a number of years ago.  Professor Hodrick has been most generous over the years in allowing me to go into her class and spout off about what, in my view, the case really tells the students.  And, as readers of this blog will probably know, my opinions don’t always conform to the standard view.

The talk is an opportunity for me to expound on a subject that I am convinced is an important, but underdeveloped, line of inquiry on corporate behavior.  That is, what happens when corporate plans incorporate financial theory that runs counter to a company’s prevailing corporate culture?  It’s always fun to talk about this in a financial analysis class setting, because it’s one of those “soft” issues that drive finance people nuts.  You can’t quantify it very easily and usually wind up talking about it through the use of anecdotes.  But I’m convinced it is very real and contributes considerably to the success or failure of many corporate projects.  

In the case I help teach at Columbia, the subject matter revolves around Walgreens’ plans to generate cash through increasing inventory turns, running counter to their retailing culture of having lots of inventory on hand for their customers.  There are plenty of other examples from real life, including Hewlett Packard’s reorganization a few years back running smack dab into “the H-P way”, Home Depot’s centralization efforts wrestling with the famously decentralized culture of their store managers and Rite Aid drugstores attempts to change from a chain of small stores with tightly controlled expenses to larger, sales driven stores.  All of these proposed changes looked eminently reasonable and logical when they were proposed, but in retrospect, never came close to achieving what was planned for, as the unseen forces of corporate culture threw a monkey wrench into the finely tuned plans. 

Which brings me to the point I want to make as it relates to investor relations.  Corporate culture matters.  One of the principal jobs of an investor relations officer is to bring color, understanding and nuance to the basic information surrounding a company.  Probably the most important piece of nuance that you can help investors understand about your company is the culture in which it operates.  The numbers from the financial statements are there for everyone to see and you don’t bring much value if all you do is regurgitate the numbers.  Where value is added is when you help investors understand why the numbers are the way they are.  This involves the ability to explain a variety of factors, including industry trends and company specific actions.  Placing things in the context of your company’s values is an integral part of this.  For example, the income statement and balance sheet of a company that is sales driven will look very different from one that is expense minded, even if they operate in the same markets.  Engineering oriented firms take a different approach to business than firms that emphasize marketing.  It is the function of the investor relations officer to place how your firm approaches business into this context.

I will finish with the following thought:  One of the hardest edged institutions I know is the United States Military Academy at West Point.  Life there is tough – highly regimented and rigorous.  They are in the business of training combat officers capable of operating under extreme duress.  Further, the curriculum at the Academy is engineering focused.  Yet much of what the Academy stresses to the cadets is not the brutal calculus of war, but “soft issues” such as “Duty, Honor, Country” and leadership.  If you want to understand what motivates our military, you are well served to understand these values. Similarly, if you want investors to understand your company better so that their valuation will properly reflect the long-term value of your firm, you need to explain your operations in the context of your corporate culture.

Friday, February 13, 2009

And You Thought Our Stock Ratings System Was Screwed Up

In the February 8th Sunday New York Times, the Business section contained an article entitled “Why Analysts Keep Telling Investors to Buy”.  It’s worth a read, even if it covers familiar ground to those experienced in the ways of Wall Street and investment analysts.  The long and the short of the article is that even in the mist of a terrible bear market, analysts still only have sell ratings on 5.9% of all stocks.  Having missed all of the warning signs for the current economic downturn, most analysts are now of the opinion that stock prices are so low that now is the time to buy.  Nobody wants to issue a sell rating just when the markets turn up.

I’ve written about this phenomenon before (see “Stock Ratings from Lake Wobegone”, May 15, 2008).  Leaving aside the tendency of the stock market to rise over time, all of the incentives on Wall Street favor the optimistic, bullish view.  When an analyst issues a sell rating, companies hate him, investment bankers hate him and commission flow goes elsewhere.  The only ones who like sell ratings are short sellers, and they are often viewed as the pariahs of the industry, commonly blamed for all sorts of financial misdeeds and shenanigans.  (My own feeling is that short sellers, like jackals and hyenas, form a natural part of the ecosystem, but that doesn’t mean we have to like them.)

None of this would be worthy of a lot of additional comment on my part, except that about the same time as I read The New York Times article, I also ran across a brief piece in the February 7th issue of The Economist magazine that made me think that maybe, as skewed as things are here, they’re a lot better than some other markets.  The article, entitled “Bye bye sell” takes a look at research recommendations in the South Korean and Taiwan markets.  In both markets it appears that government regulators actively discourage brokerage firms from issuing critical research.  In South Korea, the Financial Supervisory Service has been known to investigate brokerage firms that issue critical research, while in Taiwan, if the press quotes critical research, the government requests brokers to provide “explanations” as the press is required to receive a securities firm’s approval before quoting research.

The results are predictable, as the research firms quickly learn that critical research brings more trouble than it’s worth.  For example, during 2008, there were 17,335 research reports issued in South Korea, and not a single one was a sell recommendation.  This is not what you think of when you start talking about efficient markets.  As bad as our distribution of stock recommendations is in the U. S. we are not burdened by a government bureaucracy that views stock markets as an instrument of optimistic government policy. Yet.  

Thursday, February 5, 2009

XBRL – Part Deux

Much to my surprise, my recent post about XBRL has generated more emails than any other post I’ve written.  People from London and Washington D. C. have offered to help me see the error of my ways, so I’ve decided to continue to try and see the light.  (But, I mean, who would have thunk? This seems like a pretty dry topic to me.) 

I’m at an age where I’m not embarrassed to say that there are some things I just don’t get.  For example, in Game Theory class I never did figure out who was wearing that damned ret hat.  Be that as it may, this stuff is like an unscratched itch and it bothers me until I get some semblance of understanding, dim though it may be. 

So I went back and did some more digging on the web and I found an article about the 18th XBRL International Conference held in Washington, D. C. last October.  What caught my eye in the article was a presentation where a Microsoft official stated that his company had already installed a XBRL enabled tool on its Investor Central website.  The specific statement was that the site allowed investors to drill down into segment results that sum into top line numbers on the financial statement.  I thought, “Ah ha, here’s a concrete example of XBRL in use that can really help me understand what’s going on.”  So off I went to the Microsoft website to look at the way they report segment results in their Investor Central.

I’ve inserted a screenshot of what I found.  The first page under segment reporting gives you the breakout of revenue and operating income.

If you click on one of the line item headings, it takes you to another screen (shown below) that drills down into the line item detail and the language from the Management Discussion and Analysis section of the 10-Q that discusses that segment.  So far, so good – it doesn’t give you any more information or insight than reading the 10-Q, but it assembles the data in one spot so that you’re not confined to the logic of a governmental filing form as you try and figure out what Microsoft’s various business segments are doing.  Nice, but hardly revolutionary.  Then I took a closer look at the way Microsoft had laid out the information and I lost my appetite for XBRL. 

The segment I had chosen by random to look at was Microsoft’s Online Services Business.  Microsoft starts the page with a headline stating “Online advertising revenue grew 7% in a weak ad spending market” and follows it up with three bullet points about search revenue up double-digits, continued display revenue growth and healthy engagement growth in page views and search queries.  It all sounds very positive until you look down into the actual detail pulled over by XBRL and you see that actual revenue growth for the segment was flat and oh, by the way, operating losses increased by 91% to $471 million.  Maybe that’s just a rounding error to Microsoft and not worthy of a mention, but it sure seems like a lot of money to me. What Microsoft did was to take the opportunity created by having an additional, non-SEC filing page to create some positive, non-XBRL commentary in order to try and spin the results on a horrible quarter in the segment.  If this is XBRL, you can have it; I’d rather try and figure things out without the commentary trying to divert my attention elsewhere.

Also, curiously enough, something appears to be awry with the transporting of data, as the last sentence on Microsoft’s web page refers to “headcourt-related [sic.] expenses” whereas their 10-Q filing gets it right.  If this data is just being moved around automatically, how could that happen?  And how confident does that make you feel that all the numbers have been transported correctly?

Maybe I’m just a skeptic (regular readers of this blog knew that already), but I don’t see what all the fuss is about with XBRL.  It’s just rearranging the data that we already had, which to me seems like a lot of work for not much benefit.  Better understanding and benefit come from working through the data.  Balanced against this we seem to have given companies yet another opportunity to spin the data.

Then again, maybe I’m just an old curmudgeon and this is another instance of not being able to figure out where that damned red hat is…