Tell Them Why

Following on to last week’s post about what investor relations presentations can learn from jazz, this week I take my inspiration from a different pod cast, Ted Talks. Anyone who is interested in communications should listen (the pod casts are available on ITunes) or watch Ted Talks (http://www.ted.com/), where you can find some of the best and most passionate speakers on a wide variety of topics. The TED Talks speakers have the ability to grab and hold their audiences, and if you are in the business of communicating ideas, there is no better way to learn about the process than to watch speakers such as these.

The talk that caught my attention and which I think can be instructive for people trying to get their story across to investors was one by Simon Sinek, the author of a book entitled “Start With Why”. The talk, which I gather distills the main idea of his book, offered one overarching thought, which is “People don’t buy what you do, they buy why you do it”. In a world where there are many competing products and services, the thing that distinguishes the winners and makes them appealing is the underlying passion that forms the core of their product or service. The example Sinek talked about is Apple and how they inform everything they do with a passion for combining technology, design and ease of use, but there are plenty of other examples out there. Everything Wal-Mart does is designed to deliver products to their customers at the lowest price possible. Toyota sells Lexus automobiles based upon a relentless pursuit of excellence. Whole Foods wants to deliver better and more wholesome foods.

When you start to think about this in the context of investors, who are purchasing the future stream of cash flows of your company, it starts to make eminent sense to bring to the fore the why of your company. Products, markets and service offerings change over time. Who your company is and why they do things in the manner they do changes far less often. Investors need to know what informs your basic philosophy and culture, because that is part of what they are buying: it goes into everything your company does.

Yet if you look at most investor presentations, what you find is that companies are good at telling what they do, but not why they do it. What they do is something that can be quantified or visualized. Why they do what they do is much less easy to explain. So my thought for the day is: the next time you are putting together an investor presentation about your company, stop and think about the why of your company. Is your motivation to be the very best at providing customer service, are you experts at solving technical engineering issues or perhaps you want to deliver the best combination of value and product offerings to consumers? Every company has a motivating factor and good investor relations dictates that it should be placed on display for investors to make a judgment about.

As for me, I’m passionate (and opinionated) about getting people to understand the principles of good investor relations.

What IR Presentations Can Learn from Jazz

I was working out the other day and listening to one of my new favorite podcasts, NPR’s Driveway Moments. The particular segment I was listening to featured an interview with the jazz musician Wynton Marsalis, who was explaining jazz to the uninitiated. I definitely fall into that category, as I don’t “get” most jazz. Several of the things Wynton Marsalis said caught my attention and made me think that there are some interesting parallels between some things we see in music and investor relations presentations.

Most investor presentations are set pieces: you’ve got a speaker, a set of PowerPoint slides and a bunch of information that gets disseminated over the course of 30 minutes. In this they resemble classical music. They follow a prescribed score and they don’t deviate. The speaker covers every last bullet point, just as the musicians play every note, and everyone feels safe and secure because they are on familiar ground. The speakers, similar to orchestral players, are almost interchangeable and it’s very hard to see any individuality or emotion.

This approach has some merit in that everyone navigates the treacherous shoals of regulation and potential litigation and (usually) nobody gets fired. The problem with the approach is that it’s boring and it’s not very good at getting investors excited about your company’s prospects. And investors are buying the future stream of earnings of your company, not its past deeds. Next time you’re at an investor conference, sit and listen to three or four presentations in a row. I guarantee that you will be numb at the end of the last speaker.

Contrast this with jazz. There is a structure with rhythm and melody, but there is also room for some improvisations and solos. The improvisations and solos have to fit within the framework – they don’t work if they don’t fit into the structure of the piece, but they also allow for the expression of talent and passion for the subject matter.

More passion is needed at investor presentations. Speakers should be allowed to get excited about their companies and what they’re doing. They should have a passion and a pride in their products and people and it should show through to the investing public. This is very hard to do if what you’re saying is highly scripted.

One of the masters of conveying the excitement about what he was doing was a guy I used to work with at Walgreens, Dan Jorndt. He never worked with a script, but he always knew what he wanted to say. He put things in his words and allowed his passion and pride in the company to show. Investors loved him. Another master of the art is Howard Schultz at Starbucks. Not only can he convey the romance of a cup of coffee, he is passionate about what his company stands for, from the product to the entire customer experience. If you’re ever at an investor conference and he’s speaking, take the time to go and listen to him.

Now, I can sense that many IR officers out there are squirming and thinking, “We can’t do that with our guys, they’ll go right off the rails and into the ditch”. And perhaps the approach is not for everyone. Some speakers need more structure than others, but all speakers should be allowed to exhibit what they think makes their company great. And that doesn’t come from reading a bunch of bullet points off a slide. At the very least there should be a point within a presentation where a speaker can speak from the heart, whether it’s to tell a story about an employee or a customer, or the great new product the company has developed. To put it in a jazz context, a riff or solo within the structure of the piece that serves as an exclamation point to the entire presentation. Try it – you just might acquire a taste for it.

Who Are You Going to Believe – Me or Your Lying Eyes?

Trial lawyers have a cheap, but effective trick when they catch a witness in an inconsistency. They simply ask, “Well, are you lying now or were you lying then?” I sometimes get the same feeling when I compare management statements with the risk factors disclosed in SEC filings.

For example, there was a recent blog post at Footnoted (http://www.footnoted.com/pr-spin/spinning-hidden-meanings-at-walgreen/JUNE 29, 2010) that pointed out exactly just such a discrepancy between management and the lawyers over the impact of Walgreens’ participation in prescription drug plans administered by CVS, a rival drugstore chain.

Walgreens and CVS, bitter rivals, also do business together by virtue of the fact that CVS owns Caremark, a large pharmacy benefit management company. Many prescription takers are in plans administered by Caremark, but choose to get their prescriptions filled at Walgreen retail stores. This, of course, was bound to be a troubled relationship, and sure enough, earlier this summer, Walgreens announced that it would no longer take new prescription plans administered by Caremark. After CVS, in a fit of pique then announced that it was terminating Walgreens participation in all pharmacy benefit plans, Walgreens released a statement by Kermit Crawford, executive vice president of pharmacy stating: “Regardless of CVS Caremark’s decision, we are confident of our ability to continue to grow our business as a provider in hundreds of other pharmacy benefit networks and as a direct provider to employers.”

Walgreens and CVS subsequently reached a new agreement and that was that until Walgreens filed its most recent 10-Q where, out of the blue, a new and previously undisclosed risk factor was discussed. In what seems to be a direct acknowledgement of the potential impact of losing the Caremark plans, the risk disclosure states:

“We derive a significant portion of our sales from prescription drug sales reimbursed through prescription drug plans administered by pharmacy benefit management (PBM) companies. … If our participation in the prescription drug programs administered by one or more of the large PBM companies is terminated, we expect that our sales would be adversely affected, at least in the short term. If we are unable to replace any such lost sales, either through an increase in other sales or through a resumption of participation in those plans, our operating results may be materially adversely affected.”

Now, I suppose you could say that Walgreens was merely posturing in saying that they were confident they could continue to grow their business in spite of losing the Caremark business, but that’s the sort of thing you do at the negotiating table, not in a press release. Investors expect and deserve consistency. The original statement is patently at odds with the risk statement, so I’m left with the basic question: Should I believe what you say now or what you said then?

(Full and fair disclosure: by virtue of having worked at Walgreens for over twenty years, the author has a significant financial interest in the company. I want them to get it right, which is why I get so upset when they screw up.)

Make Your Financials Easier to Understand

In my opinion, most companies do a lousy job presenting their financials on their websites. It’s not that the information is not there; it’s just that companies don’t make it easy for investors to work with the data. I find this surprising given that financial information is the lifeblood of understanding how a company is doing, but it’s probably part of the regulatory mindset of investor relations. Many companies will disclose their financials to the extent and in the form regulations require it, but no more than that.

Computers and the web give us lots of innovative ways to present financial information in an interactive and easy to use manner. Yet most financials I see on the web are static and limited in scope, with little to no interactivity. This means that companies are forcing investors to laboriously build spreadsheets by copying over information and then creating formulas to calculate ratios. We’re starting to see this change a bit as you can now copy and paste the basic numbers with the use of XBRL, but it’s still not that easy to deal with, and the time periods are limited to those set out in the 10-Q and 10-K formats. And don’t even get me started about the pain and suffering involved in creating useful graphs.

Just to prove my point, I went out and looked at the web sites of four major players in the discount store sector, Wal-Mart, Costco, Target and BJ’s Warehouse Club. Here’s what I found:

Wal-Mart: provides quarterly press release financials, SEC filings and their Annual Report. The financials from the Annual report are in pdf format with three years of income statement and cash flow data and two years of balance sheet data, as you would find in a 10-K.

Costco: same as Wal-Mart.

Target: In addition to the same information provided by Wal-Mart and Costco, Target also provides Summary financial information in pdf format for their consolidated financials, retail segment and credit card segment for varying periods of time.

BJ’s Warehouse Club: The smallest of the four companies mentioned here, BJ’s actually goes one better than everyone else by providing, in addition to press releases and annual reports, an excel download capability for their 10-Q and 10-K filings, based on XBRL technology. (This information is also available for the other three companies, but you have to go to the SEC website to get it.)

In this day and age, there ought to be a better way to present the financials so that investors can get to the information they want quickly and with a minimum of effort.

And there is. A company by the name of Virtua Research (http://www.virtuaresearch.com/) has created a product, which they call Interactive Analyst Center, which allows investors to go in and look at multiple years worth of data, ratios and charts, in an easily accessible format. I’ve spent some time looking at the product and I like what I see.

The product allows companies to set up their sites to provide financial information to investors that they can use quickly and easily. For example, on the site I reviewed, there were five years of annual and quarterly financial data available. There was also a page that computed over 40 different financial ratios and even included some non-financial operational ratios that the company considered important. Finally, the part that I thought was the slickest, a charts page allows the viewer to go in and create charts with only one or two clicks.

I think many company websites could benefit from this product, as it compiles financial data about a company into a single easy to use package. In short, it allows investors to analyze instead of spending their time gathering data and crunching numbers. In this day and age of time stressed investors and short attention spans, anything a company can do to help investors get a handle on their financials should be worth a look.

(Full and fair disclosure: I have a potential financial interest in this product if sales result from referrals, so feel free to mention my name. It would be the first time I’ve made money from this blog.)

Say on Pay and Proxy Access – Start Thinking Now About Talking to Investors

The history of legislative and regulatory reform relating to Wall Street is one of egregious excess, followed by financial distress, resulting in laws and regulations being enacted. It first played out with the boom and bust of the Great Stock Market Crash of 1929, which gave us the Securities Act of 1933 and the Securities and Exchange Act of 1934. We saw a replay following the Enron/Adelphia/Worldcom/Tyco frauds in 2000, which resulted in the Sarbanes/Oxley Act. And now we are seeing the same scenario following the financial crisis of 2008 – 2009 as Congress is feverishly putting together a financial reform package.

I generally try not to pay too much attention to the legislative process, as things change frequently and the process is not pretty to watch. However, there are a couple of things that will likely be included in the current bill relating to corporate governance – proxy access and say on pay - that investor relations officers should be thinking about.

Corporate governance issues have traditionally been an area that falls within the purview of the Corporate Secretary or General Counsel with investor relations only becoming involved if the vote doesn’t look good or if some form of a contest is looming. As activist investors have increasingly turned to proxy proposals to agitate for corporate change, investor relations has gradually become more involved in the process because they are the ones that know the investors. If proxy access and say on pay are going to open up corporate governance to more public scrutiny, it behooves investor relations practitioners to start to get more engaged with the people who vote the proxies.

Of course, when you take a hard look at who does the voting, you realize that IR people have their work cut out for them. You can generally break down investor voting blocs into three categories: active long-term investors, passive investors and active short-term investors.

Active long-term investors usually don’t want to be bothered by this stuff. Portfolio managers and analysts want to analysis stocks, not get involved in corporate governance. Their compensation is benchmarked against their performance relative to an index, not against good corporate governance and they spend their time accordingly. The result is that these decisions are handled by either subscribing to one of the services such as ISS/Riskmetrics, handing it off to an internal committee if the firm is large enough, or by voting with their feet and selling the shares if they don’t like what management is doing. As a result, the typical investor relations officer usually doesn’t talk to the person casting the proxy vote.

Passive index investors can’t vote with their feet by selling the stock as long as a company is in an index, so they all have committees and policies regarding how to vote on governance items. From an investor relations perspective however, you never talk to these passive shareholders, so you don’t know anything about their committees.

Active short term investors are here today and gone tomorrow, so by the time they appear on a 13 D report, they may have well sold the shares and moved on.

I would suggest that investor relations departments need to be proactive in discussing potential vote issues with the people who actually vote the shares. I’ve written about this before (see my post of February 10, 2010), but here are a couple of suggestions to bridge this gap: First, well in advance of proxy season, investor relations officers, together with their securities law counsel, should schedule a number of calls to key investors (both active and passive long-term investors) to discuss current disclosure issues in areas such as compensation and governance. The calls should be designed as a dialogue to discover how these investors view the topics, not as advocacy. as you can’t solicit votes without a proxy statement. What investors are interested in can then be incorporated into your compensation and governance disclosures. Secondly, when you’re out on non-deal road shows, ask to spend five minutes at the end of a visit discussing the firm’s views on disclosure issues, whether they be compensation, governance or social responsibility. This actually makes for a nice break in the road show meeting rat race as it introduces a new topic into the discussion. In the larger firms this will mean that they will have to bring in someone at the end of the meeting, as there is usually a separate person that deals with proxy voting, but it is well worth the effort as it gives upper management an opportunity to hear investors’ concerns and thinking.

This doesn’t solve all issues, as sometimes the interests of investors about compensation and governance structures are different from management’s, but at least you’ll know prior to the vote being cast and can do more accurate predictions at proxy time.

Corporate Governance Ratings – What Are They Good For?

Way back in 1970, there was a Motown record that had as its catch phrase, “War, what is it good for? Absolutely nothin’!” Today, there is research that suggests that the same can be said about corporate governance ratings.

For the past ten years or so, investor relations practitioners have been drawn into the debate on corporate governance. It’s not that IR practitioners have a special expertise in corporate governance, or that many of them really want to become experts. It’s just that Boards of Directors have been under increasing scrutiny to comply with a list of “best practices” compiled by groups such as Institutional Shareholder Services (“ISS”), Governance Metrics International (“GMI”) and The Corporate Library. Directors do not like it when shareholders withhold their proxy votes for failure to meet minimum corporate governance scores. And it’s investor relations that talks to the shareholders, so IR people find themselves working with the Corporate Secretary and the General Counsel to find out how they can achieve the highest possible corporate governance scores to present to shareholders while actually changing corporate practices as little as possible.

The underlying premise of the governance rating services is simple, yet compelling on its surface: companies that focus on corporate governance as indicated by high ratings will, over time, generate superior returns and economic performance and lower their cost of capital. Conversely, companies weak in corporate governance as shown by low governance scores represent increased investment risks that should be penalized by a higher cost of capital.

But did you ever take a step back and wonder whether the corporate governance ratings have any value in actually predicting poor corporate governance or performance? I certainly have. And so too, it seems, have Professors Robert Daines of Stanford, Ian Gow of Kellogg and David Larker of Stanford. In a recent scholarly article, “Rating the Ratings: How Good Are Commercial Governance Ratings?” which is to be published in a forthcoming issue of the Journal of Financial Economics they look at how effective corporate governance ratings are in helping shareholders figure out if companies with high corporate governance scores are actually better governed. The findings are so startling and unequivocal that I am going to quote the article abstract in its entirety:

Proxy advisory and corporate governance rating firms (such as RiskMetrics/Institutional Shareholder Services, GovernanceMetrics International, and The Corporate Library) play an increasingly important role in U.S. public markets. They rank the quality of firm corporate governance, advise shareholders how to vote, and sometimes press for governance changes. We examine whether commercially available corporate governance rankings provide useful information for shareholders. Our results suggest that they do not. Commercial ratings do not predict governance-related outcomes with the precision or strength necessary to support the bold claims made by most of these firms. Moreover, we find little or no relation between the governance ratings provided by RiskMetrics with either their voting recommendations or the actual votes by shareholders on proxy proposals.

Inside the article the language is even stronger. Here’s my favorite quote: “One especially interesting result is that CGQ (perhaps the most visible governance rating) [Corporate Governance Quotient, a measure devised by RiskMetrics/ISS] exhibits virtually no predictive ability, and when CGQ is significant, more often than not it has an unexpected sign (e.g., higher CGQ seems to be associated with lower Tobin’s Q, and in some models more class-action lawsuits).” In other words, high governance scores have virtually no value, and companies that put in all of the so called best practices are actually more likely to be worth less and get sued more often.

What all of this suggests to me is that good oversight by the Board of Directors and good management of the shareholders’ assets is not a function of a formula or a list of practices. Rather, the way Boards and managements function needs to be examined by investors on a case-by-case basis in relation to their cultures and their track records. How Boards function does need more transparency so that investors can judge for themselves if they are practicing good stewardship. But those that think that good governance can be boiled down to a single number score are just kidding themselves. And if you are paying to get advice on how to increase your governance scores, you’re wasting corporate assets.

Corporate Life Cycles and Investor Relations, Part 2

In my last post I wrote about the commonality between the product life cycle chart and corporate life cycles and some of the implications this has for investor relations. To recap, where you are in terms of your corporate life cycle is a large determinant in whether you get Growth, GARP, Value or Deep Value investors. As each of these different styles of investors is willing to pay differing amounts for your future earnings, the valuation you get in the stock market will in no small degree be influenced by where investors view you in your life cycle. To carry this one step further, in this post we will look at how companies seek to avoid the point at which they transition into a mature, and then declining company and how successful this is in avoiding a declining P/E ratio.

In product development, when a product threatens to become mature, the marketing people move in and try to rejuvenate and refresh the brand by introducing new product features and formulations or market applications. The idea is to boost sales volume and market penetration. Nobody wants to get to the point where a product is mature, verging on stale, and headed for inevitable decline. In graphical terms, what they do looks like this:

Companies do the same thing. A great example of a company continually reinventing itself via new products and markets is Apple. First Apple was a computer company. Then they introduced the iPod and iTunes. This was followed by the iPhone, Apps and now, the iPad. Apple has been incredibly successful in this approach, helped by great design and engineering, creating a tightly integrated suite of products that customers love. And the stock market has richly rewarded them for this. As of this writing, Apple stock is trading at a P/E ratio of 23.8, placing it in very exclusive territory for companies with over $100 billion in market cap.

Companies do not do this with just new products, however. Companies attempt to extend their progress up the growth curve through acquisitions, entering new markets, entering new territories, going global, reengineering their work processes, expense initiatives and a raft of other things too numerous to mention. In doing this they hope to extend their growth and the premium investors will pay for their future earnings. The problem with all of this, from an investor’s viewpoint, is that the new products, programs and initiatives don’t have a track record. Therefore, the certainty with which future earnings from these programs can be predicted is less than it is for existing operations and the willingness of investors to pay up for the incremental earnings is less. Unless and until a company can establish a track record for successful entry into new products or markets or initiatives, investors will discount the future earnings at a greater rate than the old familiar type of earnings. Investors just don’t like uncertainty. So revenues may go up; earnings may in fact also go up, but P/Es will fall until a company can demonstrate that it has as one of its core competencies the ability to extend its growth with new initiatives.

Again, if we look at Apple, the first Ipod was introduced on October 23, 2001. Following the announcement of the new product, one that turned out to be revolutionary, Apple’s stock price didn’t do much for the next couple of years. Investors had a wait and see attitude.

This, of course, drives corporate management nuts. They have invested millions of dollars in a new initiative through design and engineering, consulting fees and countless meetings and studies. They are embarking on a bold new strategy to push their company forward for the next millennium. And yet, in their view, the market doesn’t get it.

Investor relations professionals should learn to recognize this type of fact pattern and be ready to explain to management why the stock didn’t jump when the CEO’s latest initiative was announced. Much heartburn can be avoided if companies take a realistic approach to how the market values new corporate actions. There is no real way around this – companies have to prove themselves to investors on new initiatives to a far greater extent than for existing operations. But as witnessed by Apple, it can be done.