Starbucks’ Grande Mistake

Yesterday Starbucks announced its first quarter results, a 2% gain over the same period a year ago.  This is a weak performance by Starbucks’ standards and was accompanied by a number of announcements regarding initiatives to turn Starbucks back into the Starbucks that people used to love.  What caught my eye, however, was the simultaneous announcement that Starbucks was now longer going to provide same-store sales numbers.  I think this is a grande mistake on the part of the company.

 

Now, for those of you who do not immediately see the impact of this, allow me to enlighten you.  I worked in the retail sector for 23 years at Walgreens and for 15 of those years I was responsible for their investor relations.  Walgreens released same-store sales on a monthly basis so that means that I went through about 180 monthly cycles of releasing sales numbers.  I can tell you that same-store sales are the most closely watched indicator in the retail arena.  The numbers help investors figure out if you are growing in your more mature stores and how successful your merchandising initiatives are.  And while everyone knows that one month’s sales do not necessarily set out a trend, a series of same-store sales numbers will certainly help people understand where the business is going.

 

So, just when things are going bad, Starbucks has decided to communicate less.  I don’t agree with what they are doing, so I took a careful look at the reasons they set forth for their actions, as reported in The New York Times and The Wall Street Journal.  (I find that I need to read both newspapers to get a balanced view of the world – one pulls you to the left and then the other pulls you to the right, so you wind up in the middle.)  What I found were two justifications for the decline in communications.  First, they said that a focus on increasing same-store sales is part of what led them away from their core strategy of creating a Starbucks experience, and second, same-store sales numbers would be “erratic” during the transformation.

 

Frankly, in financial terms, this is a lot of baloney.  The reason the Starbucks experience changed is that they stopped acting like a neighborhood coffee shop with a focus on coffee and started acting like a chain restaurant.  Everything became standardized, with a focus on cutting wait times and controlling the process.  This worked when the economy was robust and there was little competition, but things are tougher now. 

 

As to the second reason, Starbucks was happy to report same-store sales as long as they were robust, giving people the impression that they were going to grow to the moon.  Now, when same-store sales might be erratic, analysts can no longer be relied upon to draw the proper conclusions (read: conclusions that are favorable to Starbucks).  It doesn’t work that way.  You can’t close the curtains on the wizard.  If Starbucks thinks that they are going to enter a period of erratic same-store sales because of the transformation they are attempting, they should be prepared to explain to investors what they are doing, the impact it has on sales and how they believe it will improve sales in the long run.  That’s part of being a public company.  To put it into consultant speak, where performance plus perception equals stock price, Starbucks is cutting off an important component of the performance portion of the equation, which will throw into doubt investors’ perceptions of the company.

 

I think Starbucks is a terrific company, one of the great growth stories of the past 20 years.  I’ve been to one of their analyst days and I am convinced that they are one of the best marketing companies around.  They sure know how to sell the romance of a cup of coffee, creating a premium product out of what was once considered a commodity.  I just think they’re dead wrong on this issue.  I’ve seen the “No Same-Store Sales Numbers” movie before, Home Depot version, and it did not have a happy ending.

The Regulatory Mindset of Investor Relations

Last week I attended the Rice Marketing Case competition where eight of the nation’s best business schools came to Rice and in the course of 24 hours analyzed a case and made a presentation of their recommendations to a panel of judges.  It was quite interesting to see how the same problem generated significantly different responses.  I am happy to report that students from my business school alma mater, Kellogg, won the competition, besting teams from, among others, Harvard, Yale, Wharton, The University of Chicago and (alas) Rice.

 

After the competition, I naturally headed for the reception.  Listening to four hours of marketing presentations will build up a mighty thirst.  I was busy easing that thirst on about my second glass of wine, when a fellow attendee I was chatting with turned to me and asked, “What companies do you think do a really good job in investor relations?”  I think she was trying desperately to come up with a topic to talk about because a few minutes earlier when I told her I did investor relations consulting, I was met with a blank stare. (Well, what can you expect from marketing people?)  The thing is, I was stuck for an answer.  My apologies to all of you out there with terrific IR programs, but none came to my mind.  After an awkward pause, I explained that generally I worked with companies that had need of improvement in some area, so I couldn’t name any single company that did everything right.  To keep the discussion going at that point, she then asked me “What is the most common failure in investor relations that companies have?”  Now here was an answer I could sink my teeth into, and I will devote the rest of this post to discussing my answer to her.

 

The single most common failure that investor relations programs have is that they approach the function as a regulatory function rather than one that conveys strategic information about the firm.  In other words, because the minimum disclosures about a firm are regulated by the SEC, many firms view that as being all that they should say about their business. 

 

In the early days of my career, I worked as a corporate attorney.  My practice encompassed everything from real estate to corporate law to securities regulation. One of the things I learned about attorneys that work in a regulated industry is that when they are confronted with a question, they have two default positions.  The first is to examine the facts and see if they fall within the language of the regulations.  If the regulations didn’t allow you to do what you wanted to accomplish, the second step is then to see if there is an exemption available.  If no exemption exists, then the answer is “No, you can’t do that”.

 

To a large degree, this sort of thinking has infiltrated the practice of investor relations.  Disclosures are highly regulated, lawyers and accountants review everything, regulation fair disclosure hangs over everything you say and the threat of lawsuits for misleading statements is omnipresent.  The result is that the default position for most companies is to say as little as possible.  Most lawyers’ advice is that if you stick to saying only what is required by the regulations, you won’t get in trouble.  Of course, your stock is not likely to get much of a valuation, but that’s not their problem.

 

One of the common frameworks of investor relations is: company performance plus the perception of future performance equals stock price.  If a company is sticking to the bare regulatory minimum of disclosure, I would argue that they are only giving investors the half of the equation relating to company performance.  Regulations do require companies to talk about forward looking initiatives, but frankly, if you’ve ever spent any time reading through Form 10-Ks there is generally so much weasel language and so little meat on those disclosure bones that an investor can’t make a reasoned decision based on what they read.

 

So my advice is for companies to open up about how they achieve their results and where they see themselves going.  Talk about the key drivers of your business.  Discuss your view of the markets and where you need to go to be successful. Engage in meaningful disclosures between quarterly filings.  Be upfront about corporate initiatives and update them frequently with meaningful statistics.  There will be rough patches - new initiatives rarely go smoothly, but in the long run investors will understand your business better and assign it a valuation that combines both where you are and where your company is going.

 

I got done with my answer, feeling pretty smug about what I’d said, then I looked at the person I was talking to.  She had a dazed expression on her face, looked at her wine glass, said she needed a refill and wandered off towards the bar.  I guess good investor relations is enough to drive a person to drink.

What is Investor Relations Worth (Revisited)

My wife, who claims that one of the great proofs of her love for me is that she allows me to keep a dog, always buys every member of the family a new calendar at Christmas time. This year she bought me a calendar featuring dog cartoons from The New Yorker. The cartoon on the cover shows two dogs and one is saying to the other, “I had my own blog for a while, but I decided to go back to just pointless, incessant barking.” Of course, sometimes it’s hard to tell the difference.

One of the most common laments I hear from investor relations officers is that it is difficult, if not impossible, to measure the value of investor relations. It reminds me of the old saying about advertising: “Half of my money is wasted on advertising, the problem is, I don’t know which half”. I suppose it can also lead to IROs questioning their own worth, but we need not stray into such troublesome waters here.

Good investor relations is especially difficult to measure, as there generally are no baselines to gauge it against. You try to look at competitors’ valuations, companies with similar characteristics, the market in general and whatever else comes to mind. From that you hope that a pattern emerges, but whatever pattern may be there is often lost in the overall performance of the company. You often feel as if you’re dancing around the issue without really coming to grips with it.

When things go spectacularly wrong, however, there is a chance to measure damage more precisely. Academics call this an event study and crank out hundreds of them in learned papers accompanied by complex mathematical equations of the sort that gave me nightmare during my freshman year of college. My goals here are a bit more modest.

You might recall that Sallie Mae (NYSE:SLM) hosted a conference call with analysts on December 19, 2007 that was one of the worst examples of its kind. On the day of the call, Sallie Mae lost $3 billion of market capitalization. A month has now passed and given that Wall Street always initially overreacts to both good and bad news, I thought that after a month’s time it would be instructive to see where things stand.

Devoted readers of this blog (yes, there are a few) will recall that back in August of last year I quoted a study by Rivel Research where a survey of buy side investors showed that they thought good investor relations could add as much as 10% to a stock’s value, while poor investor relations could subtract as much as 15% from the value of a stock. From this perspective, here is how Sallie Mae’s disastrous investor relations foray into conference calls stacks up against the broad market and the NYSE Financial index:

Date                         SLM      SPX 500    NYSE Financials
12/18/07                 28.87    1454.98     470.55
12/19/07                 22.89    1453.00     471.25
1/14/08                   20.30   1416.25      450.55
first day % chg      -20.7%  -0.14%       +0.15%
One month % chg -29.68% -2.66%     -4.25%
(Note: I have chosen the date of 1/14/08 as the measurement date because that represents the highest price for SLM in the week leading up to the one month mark from the conference call in question.)

So comparing Sallie Mae’s best price against the worst performing index, they underperformed by approximately 25%. I think this lends some credibility to the values that Rivel research assigned to investor relations. Granted, it is a case study of one (and an extreme one at that) and by itself would not stand up to rigorous academic peer review, but it sure points in the right direction and seems to be in the same range.

So, investor relations officers take heart! There is meaning and value to your function! You add value to your company even if you just convince your senior management to prepare for conference calls and not wing it. Remember, the smartest thing you may do is to convince people not to speak unless they have something intelligent to say.

How Not to Run a Conference Call

Yesterday Al Lord, the CEO of SLM Corporation (Sallie Mae) held a conference call to reintroduce himself to the analyst community (He had previously served as SLM’s CEO and CFO). The purported purpose of the call was to bring some transparency to his role as CEO and to talk about some broad issues and goals for SLM. He certainly brought transparency to his role as CEO. What the Street saw was an executive who was by turns vague, defensive, arrogant and profane. Investors’ reactions were what you might expect – the stock traded down 20%, the worst one-day drop in the company’s history. As this is an example that we can all learn from, I thought I would dissect the call in more detail for our edification.

There were many issues that needed to be addressed on the call – a failed buyout bid and ensuing litigation, lowered credit ratings and the need to shore up capital at the company, the CEO’s recent sale of 1.2 million shares and steps needed to return the company to a growth mode following the nine months the failed buyout bid was pending. To the CEO’s credit, he raised all the issues in his prepared remarks. Unfortunately, he didn’t clearly explain any of the issues or set out concrete steps to achieve his goals. Then he acted surprised and defensive when during the Q & A session analysts tried to get a bit more specificity out of him.

Take for example, the issue of shoring up capital. According to the transcript, Al Lord said: “My goal, first goal, probably my first goal and second goal, is to strengthen our balance sheet. The deal, the unfinished deal, cost us a single-A rating. We're now BBB. First objective is to solidify that BBB, next goal is to improve it from BBB to single-A. It is very much my first priority. In order to do that, obviously, we're going to add capital …” There was nothing said about how capital was going to be added. Predictably, the first question during the Q & A session was about how the capital was going to be raised. Here’s a portion of the exchange:

Analyst: “I wanted to ask -- you're going to shore up the balance sheet. Does that mean you're going to be selling equity?”
Al Lord: “The most preferred type of equity is common equity. At this point, I'm not going to get very precise with you. The idea is to strengthen the equity, the capital count with financing somewhere beneath the long-term credit line.”
Analyst: “Do you think you would need to raise to get back to the credit rating you would like? And what are your thoughts about the dividend?”
Al Lord: “This is the last question I answer that's more than one part. We will look at the dividend in the second half of the year.”
Analyst: “Okay. And you didn't mention how much equity you were going to need to get back up to the single-A rating.”
Al Lord: “You're talking to the wrong guy. I don't know that answer.”

This exchange is a microcosm of what went wrong with the call. The first answer is vague and indirect. A simple yes would have sufficed, as the answer seems to imply that SLM will be selling equity and would prefer to sell common equity. The answer to the last question is simply a stunner in its arrogance. Here the CEO has stated that his first (and second) priority is to add capital, yet he can’t be bothered with the details. This guy used to be the CFO, so it’s not as if he came out of sales and marketing and doesn’t know his way around a balance sheet. This is not the way to inspire confidence in the market place. There are lots of ways to answer that question without giving specifics, such as “We’ve just started studying the issue, so we’re not prepared to comment on exact amounts yet”, or “There as so many variables that can come into play as we work to improve our capital structure that it would be premature to comment on amounts of equity required just yet.”

I could go on, as there are plenty of other examples of what not to do in a conference call, from failed humor to profanity, but it’s a bit like shooting ducks in a barrel – it’s way too easy, and besides, this post would be too long. The fact that the market removed $3 billion from SLM’s market cap probably says more than I can.

So, it makes for great theater, but what can we learn from the call? Here are a few thoughts:
1. Broad, rambling statements of goals don’t cut it with an audience of equity analysts. These are people whose job is to parse the details to construct models of future earnings. General statements coupled with a refusal to go into specifics will drive them nuts. If you can’t be clear and concise, it’s better not to say anything at all.

2. Tone, attitude and preparation matter. Al Lord clearly did not want to answer questions from pesky analysts and wasn’t prepared. This sends a message that he doesn’t care about his investors and is a shoot from the hip sort of executive.

3. Never, ever, use an expletive on a conference call. Before this, Jeff Skilling of Enron fame held the award for dumbest thing ever said on a conference call when he called an analyst a particular body part. Al Lord has clearly taken the award from Skilling, by ending his conference call with “let’s get the [expletive] out of here.”

On that note, I will get the heck out of here.

Investor Relations Year in Review

Like Jimmy Buffet, I sat down last weekend just to try and recall the whole year; all of the faces and all of the places, wondering where they all disappeared. Unfortunately, unlike Jimmy, I didn’t run into a chum with a bottle of rum, so I wound up sitting right here. Writing this post, I may add. Herewith a quick review of some of the more notable things I noticed in the world of investor relations this year coupled with Palizza’s Predictions for 2008:

The World is Going Electronic: The SEC ushered in the era of more aggressive electronic delivery of proxy materials in 2007. Previously, shareholders could opt-in for electronic delivery of the proxy statement and annual report. Relatively few did. Now, companies can force them to opt out of electronic delivery. The first big annual report season for this new delivery method will occur in the Spring of 2008, and given the cost savings in printing and postage involved, most companies will make economically rational decisions and force shareholders to take action if they want to receive a paper copy of the annual report. After all, investor relations reports to the CFO, not marketing. Annual report printers everywhere have to be very concerned about the disappearance of the traditional printed annual report. Companies will like the cost savings and designers of annual reports should be neutral on the subject.

Hedge Funds and Activist Investors have a Bifurcated Year. The first half of the year saw lots of activity by hedge funds and activist investors. Deals were easy to come by and the credit markets were loose. Company managements were always looking over their shoulders to see who was sniffing around. All of this came to a screeching halt in the second half of the year as the sub-prime mortgage crisis caused the credit markets to lock up. Companies that have been underperforming or that are particularly subject to financial engineering because they have underleveraged balance sheets have gained a bit of breathing room. If they’re lucky, investor relations officers will be able to focus more on the longer term fundamentals and less on the short term trading trends in 2008.

A Corollary to the Credit Crunch: Look for the M & A pendulum to swing back in favor of strategic corporate purchasers over the next year or two, until the credit hangover eases. Of course, corporate purchasers will have to try and overcome the heightened price expectation of sellers who have seen the multiples financial buyers paid over the past few years. That should make for some interesting investor relations spiels from IROs as they attempt to justify the price being paid.

The U.S. Dollar weakened throughout the year against the British Pound and the Euro. U.S. equities must look like relative bargains to investors in Europe. On the other hand, whatever gains European investors had in U.S. equities this year were probably wiped out by currency conversions back into the Pound or the Euro. (The market giveth, and the market taketh away.) Look for more interest in U.S. equities from European investors in 2008 provided they start to think the U.S. dollar is at or near the end of its slide.

Four predictions is about all I can handle, so I will close out with best wishes for a happy holiday season for all and a prosperous new year. May the markets be kind to you in 2008!

What the World Equity Markets are Telling the U. S.

Last week I conducted a workshop on investor relations in Singapore for Asian companies. It has underscored for me the fact that we live in an increasingly global village. Yes, there are cultural differences. There are also time and distance differences that sometimes make communication difficult, but the process of transferring information from companies to investors seems to be remarkably similar worldwide.

We now have publicly listed companies in spots such as China and Vietnam. These are economies that did not even acknowledge the benefits of capitalism just a short time ago. I don’t know why, but it came as a revelation to me that companies in these countries worry about much the same things that investor relations officers do here in the U. S. – being undervalued relative to their peers and the index, managements that expect everyone to love their stock, how to measure the effectiveness of IR, and hedge funds, to name a few topics. There are differences – some of the companies I spoke with had relatively low levels of public float and a number of markets were heavily influenced by speculative individual investors, leading to volatile stock price movements. My impression, however, was that many of the differences related to the equity markets being younger, and that as the markets mature and deepen, with greater levels of liquidity and professional investors, most of the differences will work themselves out of the market.

One fact came through loud and clear however – none of the companies I spoke with were listed on a U. S. exchange, and further, none of them had any remote desire to list in the U. S. The reason universally cited was Sarbanes – Oxley. None of the companies wanted to voluntarily undertake the regulatory burden imposed by the legislation. Not so long ago, it used to be that listing in the U. S. was a sign that a company had truly arrived. Today, there are growing alternatives to the U. S. markets, including Hong Kong and London, which have more attractive regulatory environments. According to the Wall Street Journal last week, more IPOs have been filed this year in London than in the U.S. (although the U.S. is slightly ahead in dollar volume of deals).

I’m not in favor of a regulatory race to the bottom, but if seems to me that the U. S. has priced itself out of the equity listings market through the increased cost of compliance with our regulations. Clearly, the rest of the world is telling us that the increased security achieved through the oversight and controls required by Sarbanes – Oxley does not justify the increased cost. To put it another way, there would have to be a tangible benefit, shown by a premium to stock valuations for companies subject to Sarbanes - Oxley in order to justify the increased cost of complying with the regulations. Companies are not seeing it, and are taking their listings elsewhere. If the U.S. intends to remain a leader in the world equity markets, it needs to take a hard look at Sarbanes – Oxley.

Road Shows and Hedge Funds

I had the pleasure last week of attending a meeting of The Conference Board’s Global Council of Investor Relations Executives. It is an organization I used to belong to when I was on the corporate side of the equation and I think they do a good job of focusing on areas of concern for large cap corporations. The meetings are a great opportunity to hear what your peers are working on, network and listen to some interesting presentations. It is in this latter role that I was attending, having arranged to have Christopher Middleton, CEO of Atlantic Equities, discuss the merits of European roadshows for U.S. companies. Atlantic Equities is the only European based sell side shop covering U.S. equities exclusively and as a result each year they also wind up arranging a fair number of European roadshows for U.S. companies. Chris did a great job laying out the rationale for going to Europe, and every large and mid cap U. S. company should give thought to visiting with European investors as a way of broadening their shareholder base and getting away from the hedge fund merry go round that so many U.S. roadshows have turned into. (Disclosure note: the author has a relationship with Atlantic Equities and therefore is not an entirely disinterested observer.)

All of this prompted me to start thinking about why it has become such a fight to see long only investors on U. S. roadshows lately. After a moderate amount of thought (you don’t want to overdo these things), my thesis is as follows: 1. The funding for sell side research has changed, 2. You (the company) are not the client of the sell side, and 3. Follow the money.

1. The funding for sell side research has changed. It used to be that investment banking paid for much of the budget of sell side research departments. When that was happening, there was every incentive for the research analyst to maintain a good relationship with the potential investment banking client and to help facilitate meetings with the type of investors the company wants to see – long only, low turnover investors. If it didn’t result in many shares being bought or sold, well, investment banking was picking up the tab, and commission structures were higher then. Of course, Elliot Spitzer has changed all that and eliminated the inherent conflicts of interest. He’s also eliminated a strong incentive for sell side analysts to help you see the kind of investors you want to see.

2. The Company is not the client of the sell side. I think corporate IR officers often lose sight of this one. The sell side has placed more emphasis than ever before on getting management access for the buy side. The major sell side shops have entire departments that can set up road shows for you, soup to nuts, on very short notice, with only a phone call from you. As a result it feels as if you are their client. After all, they’re doing all this nice stuff for you and eliminating a major administrative headache. But you, the company, are not the client, but merely a means to an end. That end is commission flow, coming from the true client, the buy side.

3. Follow the money. Today, sell side research budgets are heavily dependant upon commission flow. And because commission rates keep falling, the most important clients of the sell side are the ones that trade the most – the hedge funds. Think about it this way – if you are visiting a city for one day, you have at most, 6 one hour time slots to see investors. When the analyst and the sales desk start to talk about which investors to see, their interest is in making their 6 biggest commission generating clients happy. You might have a top 20 investor in the city that has held the stock forever, but if they don’t generate a lot of commissions they won’t be getting a call from the sell side unless you insist upon it.

So what’s a poor investor relations officer to do? There are some things that a company can do to that can make things work for both sides. First, know the investors you clearly want to see on any give roadshow, especially if they are existing shareholders, and make your desires known at the outset. Second, recognize that the sell side will have some clients they will want you to see, and reach a happy medium. Remember, the sell side is not going to the trouble to arrange the roadshow for you without the expectation of some form of compensation, which is coming from the buy side. Third, pray that the hedge funds you do agree to see do not include the obnoxious, 30 year old who thinks he can tell your CEO how run the company.

Or, alternatively, you can go to Europe, where there are far fewer hedge funds. (For more on this topic, see my article in the September, 2007 National Investor Relations Institute Update magazine entitled “Things to Consider When Contemplating a European Investor Relations Roadshow”.)