Thursday, October 22, 2009

Loose Lips Sink Ships – What Investor Relations Officers Can Learn from the Galleon Fiasco

By now there shouldn’t be a single investor relations officer who is not familiar with the recent news that the Galleon Group hedge fund has been charged with insider trading. The case is a great example of the lengths some less than scrupulous investors will go in order to obtain information that might give them an edge on the market. Among the allegations in the government’s criminal complaint are that inside information was obtained by Galleon personnel from executives at IBM and Intel, from a McKinsey partner and from Market Street Partners, an investor relations firm.

At this point, every self respecting investor relations officer should be revisiting their corporate disclosure policy and scheduling refresher sessions with their executives on the dos and don’ts of making public statements and discussing internal information. I don’t doubt that every one of the firms named as having leaked the information had a policy in place discussing conversations with securities analysts and confidentiality of information. But periodically, people need to be reminded of it. Put succinctly, periodically they need to have the bejesus scared out of them. I’ve always found that the prospect of public humiliation, the ruin of one’s career, large monetary penalties and the possibility of jail time will focus the mind amazingly.

What investor relations officers do appears deceptively simple – they just talk to people. So naturally, executives, who have been successful in many other things within their organization, think that they can do this as well as any staff geek stuck away in an office who has never had to run a division or make real money. And thus begins a slippery slope that unscrupulous analysts are happy to exploit. Once an analyst has established a relationship with an executive, more and more information begins to slip out, inadvertently or not, until the damage is done. This is at least partly because executives do not deal with analysts every day and are probably not familiar with what the company is and is not saying publicly. Further, although they may get briefed once a year on what constitutes material information, it’s not a central part of their workday and probably not something they are likely to remember.

The short answer for companies is that unless you are a designated company spokesperson, you should not be talking to investors or analysts unless you are under supervision of someone from the IR department. You should hammer this point home with your executives. The risks in doing anything else are just too great. Remind them of this by showing them some of the people involved in the Galleon scandal doing a perp walk in front of the cameras.

In saying this I am not advocating less information being made public. I am an advocate of more and better disclosure for investors. However, that disclosure should come from people who know how to deal with the Street and the myriad of ways they will try to escalate the amount of information being given.

So the next time you have an analyst day, or a field trip to a facility, tell your executives to leave their business cards in the office. After all, you don’t want your ship springing leaks.

Tuesday, October 13, 2009

Wal-Mart and Same Store Sales: The Fallacy of Less is More

There was an opinion piece recently in the daily email reporting of IR Alert by Carol Schumacher, the Vice President, Investor Relations of Wal-Mart. In the piece, Ms. Schumacher details how Wal-Mart’s practices for reporting sales store sales have evolved over time. I read the article with some interest as I have owned Wal-Mart stock for many years and have longed believed that they were one of the premier retailers in the world. I wish I could say the same about the way they report same store sales today.

In the early days of the company, when sales were regularly outpacing everyone on the planet, Wal-Mart reported weekly comparable store sales every Saturday. This to me is ideal. It shows you have great reporting systems, a desire to keep investors informed, and by the time the company reported the quarter, one item of uncertainty, the sales number in your more mature stores, has been eliminated and the market has incorporated it into their estimates.

Alas, it could not last, particularly as Wal-Mart’s sales began to slow, and a few years back the company moved to a more common monthly reporting system. At the same time, they instituted a program to provide guidance on their view of the upcoming month’s sales. My guess (and that’s all it is) is that the issuance of guidance was a bit of a sop to the Street to ease the fact that analysts were going to get less frequent hard information and more company estimates.

This year, Wal-Mart has stopped reporting same store sales on a monthly basis and will report them only in conjunction with their quarterly earnings. Again, to sweeten the pill, they shifted to providing guidance on comparable sales figures for their U.S. and Sam’s Club stores for the upcoming quarter.

The reasons given in the article for all these changes seem to fall into three basic categories: 1. This is the way everybody else does it, 2. By giving out only quarterly numbers, they decrease volatility in the stock, and 3. Wal-Mart is focusing on more long-term metrics, which will help focus investors more on the long term.

Because I don’t agree with the direction Wal-Mart is headed in, let me try and address these issues in the order listed. First, Wal-Mart didn’t get to be the biggest retailer in the world by doing things the same way that everyone else does. The company has famously broken the mold on many retail practices and prospered. Further, this isn’t the way everybody else does it. It is only the way other companies whose sales have slowed down do it. If Wal-Mart were posting numbers that regularly showed them to be well ahead of the competition, as they were in the 1970’s and early 80’s, my guess is that they would be continuing to give out weekly comp store sales numbers. By changing the way they report, what Wal-Mart is really doing is sending a message that they think future sales will look less robust than they have been in the past.

Second, to understand the volatility issue, look at what Wal-Mart did: they consistently scaled back on providing hard data in a timely fashion, going from weekly to monthly to quarterly comp store sales numbers, while substituting guidance or estimates. Of course you are going to get guidance wrong from time to time. These are after all, estimates about future events. And when guidance varies from actual numbers, trading volatility will follow. The answer is not to decrease the flow and timing of hard information; the answer is to decrease the amount of estimates.

Third, and finally, let us turn to the issue of getting investors to focus on long-term metrics. Companies need to remember that the stock market has a split personality: over the short run it is a popularity contest, trading on the number du jour; over the long haul it is a discounting machine, using past information to discount estimates of future cash flows. It takes both short-term and long-term investors to make a market, and when you are a bellwether stock such as Wal-Mart, you will get both in droves. Investor relations officers all want the long-term buy and hold investor, but short-term investors help increase a stock’s liquidity and when a stock trades more liquidly, volatility goes down, not up.

I know that Mies van der Rohe famously said, “Less is more”, but he was speaking about architecture, not same store sales. When thinking about same store sales, I tend to follow the maxim of classically trained economists, which is: “More is always better”.

Tuesday, October 6, 2009

How to Read 10K Reports Revisited - Cracking the Code

A portfolio manager friend of mine told the following joke to the students in my investor relations class last April: Question: If you are a public company, how do you hide something from analysts? Answer: You put it in the 10-K report. There is a lot of truth to this. Reports on Form 10-K are dense, laid out in a fashion to follow a government bureaucrat’s idea of how to display information and written mostly by lawyers and accountants. This is a deadly combination.

Because of this, companies can sprinkle little tidbits of information throughout the filing and comply with disclosure requirements without really telling you much unless you learn how to read the code. (I just read the latest Dan Brown thriller, so it may influence my writing here.) To me cracking the code means opening up two or three years worth of filings on your computer, seeing what’s changed and applying some simple math. I’ve written about this before (see my blog posts dated September 10, 2008 and March 5, 2009) but I like to revisit it periodically to show how disclosure is not necessarily the same as telling you what’s really going on.

This time I decided to look at Sysco Corporation’s 10-Ks for the past three years. I chose Sysco because having worked there, I know the company well, but it’s been long enough ago so that I did not have a hand in writing any of the 10-Ks in question. Further, Sysco, which has been faced with a shift in their industry – consumers who, in the face of economic duress, are dining out at restaurants less often – seems to be managing the downturn about as well as you could expect. Because Sysco has been coping with deteriorating sales trends by reducing their expenses, I thought that if I focused on headcount, some interesting things might pop out that perhaps should have merited more discussion in the filing. I was not disappointed.

To begin, I called up three years of 10-K filings and did a word search on “employees”. It turns out that Sysco had 47,000 full time employees last year, compared to 50,000 in 2008 and 50,900 in 2007. This means that the decline in employees is 6% this year compared to last year and 7.7% over a two-year period. Interestingly, nowhere in this year’s filing does the company talk about the trend except to mention “reduced headcount” without telling what it previously was. For that you have to go back to the previous filings. This is fairly typical of what you see companies do: give you the fact, but neither explain it or put it in the context of quantity or time. They’ve complied with the technical disclosure requirement, but haven’t really explained what’s going on.

While I was going through this exercise, I also noticed that they were engaged in a similar exercise in disclosing the number of sales related personnel. This year Sysco states that they have 13,000 sales, marketing and support staff. You have to go to the previous years’ filings to find out that this compares to 14,000 a year ago and 14,400 two years ago. So the decline in sales oriented personnel was 7.1% last year and 9.7% over a two-year period. This outpaces the decline in overall headcount and the decline in overall sales, and raises some interesting questions about sales going forward, but nowhere in the filing does Sysco address this topic. For example: Does this mean that Sysco thinks they had too many sales people before? Is this decline in sales personnel an indication of Sysco’s thinking that sales are likely to remain depressed going forward? Have they reorganized their sales force along different lines? With 9,000 more customers than in 2007 (391,000 then versus 400,000 in 2009) and 9.7% fewer sales personnel, what’s happening to customer service levels? Unfortunately, you will search in vain for answers to these questions in the 10-K.

And in this, Sysco is not alone. Companies focus on checking the regulatory boxes when they write their 10-Ks. In spite of the SEC’s efforts to the contrary, these are mostly documents that look back at the previous period’s results. What investors need is something that helps them gauge the future prospects of the company by pointing out trends and important correlations. And for that, companies leave them on their own. And then they whine that investors are undervaluing them because they don’t understand how rosy their future prospects look. As Pogo once said, “We have met the enemy and he is us.”