There are a few ways that management typically responds to difficult situations; identifying which actions these managers take will help you decide whether they are an ideal partner or not.
Some managers allow current adversity to overwhelm them completely. In this type of situation, management is trying to evade the problem rather than confront it. For example, when Bear Stearns was nearing bankruptcy, then-CEO James Cayne could be found playing golf or playing in bridge tournaments. He ignored the risks the firm was facing.12
Some managers attempt to blame the problems on others or on events beyond their control. In this scenario, you will typically see heavily lawyered press releases or releases carefully crafted by public relations firms. The managers will make statements that they are assessing, reviewing, or analyzing a problem. These are indicators that senior managers are not acting—which is what they should be doing.
Some managers strike back quickly without thinking things through and often end up going in the wrong direction. These are the managers who announce layoffs in order to quickly cut costs the moment their business faces distress.
Some managers are determined to get over their setbacks but do not solve the problem; instead, they apply a quick remedy, which only solves the problem in the short run. For example, a retailer I was analyzing discovered that the reason some of its sales had dropped was that it did not have enough shopping carts in the stores. The management team quickly sent in new shopping carts but then failed to follow up later when the supply was depleted again, so of course the retailer found itself in the same situation a few months later.
The best managers are those who quickly and openly communicate how they are thinking about the problem and outline how they are going to solve it. Again, you are looking for those stories where managers acted with integrity. For example, Robert Silberman, CEO of Strayer Education, disclosed that new-student enrollments had dropped 20 percent in the 2010 winter term, the largest drop that Silberman had seen in his 10-year tenure as CEO. Even though Silberman did not know the exact reasons for the drop, he reported this negative news to shareholders the moment he had the information, and then he held a special conference call first thing the next morning to answer shareholder questions. He gave shareholders as much information as he could, and he explained how he was reacting to it.
Similarly, on the day of the 2001 terrorist attacks on the World Trade Center, Bruce Flatt, then-CEO of Brookfield Properties, had to deal with several kinds of problems. The media was circulating false reports that Brookfield’s four office buildings next to the World Trade Center were not stable and about to collapse, even though engineers had already concluded they were structurally sound. Flatt hired a car to take him from Brookfield’s headquarters in Toronto to Manhattan (because no planes were flying that day after the attacks), and he surveyed the four office towers Brookfield owned. After seeing the buildings himself and confirming with engineers that they were sound, Flatt was better able to make corrections with the media and give good information to tenants. He immediately had truckloads of plywood sent in, and he was the first landlord to start repairs in Lower Manhattan. He then promised tenants they could return in eight weeks.13 Flatt said, “We felt it was important to return to the premises as soon as possible. It was a calculated risk, but we needed to evaluate the situation, make decisions, and help our tenants.” Flatt delivered on his promise, and within eight weeks, the tenants were able to return to their offices.14
50. Are managers clear and consistent in their communications and actions with stakeholders?
The best management teams are clear and consistent in their communications with customers, employees, suppliers, and shareholders. They communicate things as they are and do not attempt to manipulate the information.
You will find that the more transparent management is about the business, the more accountable they are. In contrast, whenever managers make something complex, they may be concealing risk taking or bad judgment. Incomplete disclosure also makes it difficult for you to assess the competence of the managers. Although this may be good for the manager, reducing his or her chances of being replaced, it obviously makes your evaluation of the business more difficult.
The following sections describe a few ways you can (and should!) determine whether management is clear and consistent in its communications.
Read the Company’s Annual Report Shareholder Letter
You can start learning how a CEO communicates with shareholders by reading shareholder letters written by the CEO. By reading them sequentially, rather than reading only one shareholder letter, you will gain greater insights into the CEO and the business. You are looking for letters where the CEO communicates clearly about how the business is performing; these letters should describe and explain:
What is important at their business.
What is driving their decisions.
The issues they have encountered.
The metrics that are important to monitor the health of the business.
How the CEO plans to resolve issues faced by the business: This is one of the most important pieces of information to look for.
If, instead, the shareholder letter looks like it has been written by a public relations firm or is a carbon copy of the information disclosed in the Management, Discussion, and Analysis section (MD&A) found in the 10-K, then it is likely the CEO is not interested in giving investors insight into how he or she is thinking.
For example, if you read a shareholder letter written by Warren Buffett, CEO of Berkshire Hathaway, you might note how easy it is to understand what he writes and how authentic he is in his communications. When Buffett writes, he says exactly what he means.
In contrast, in The Coca-Cola Company’s 2003 annual shareholder letter report, former CEO Douglas Daft wrote, “I am pleased to report that our Company earned a record $1.77 per share in 2003.” This good news was coming just after the company had announced a $197 million charge, with the stock down 20 percent since Daft had been named CEO. Daft then went on to explain that this was a “particularly challenging business environment”—in other words, blaming the outside environment for the results. Daft retired from The Coca-Cola Company shortly thereafter.
Read Conference Call Transcripts
Once you feel you have a good understanding of the business, read transcripts from the most recent as well as historical conference calls. These are a great information source because if you do not have access to the management team, this is the best place to see how they communicate. You can obtain clear insight into how management thinks and acts by reading these conference call transcripts.
Watch how managers address business issues in the conference call. There is almost always a recent issue the business has encountered, and most questions are directed toward such recent issues. Are the managers open and honest in their communications? Or do they attempt to avoid the issue? Monitor how many questions go unanswered. Note if the managers use excuses, such as saying that the information is proprietary. Many management teams will use the excuse that they cannot share information with shareholders for competitive reasons. This is an extremely useful indicator: I have found that if the strategy of the business is based more on hiding information from competitors rather than outperforming competitors, it is far less likely that the business will have long-term success. If the unanswered questions have to do with specific financial guidance, this is okay. You instead want to monitor how many unanswered questions there are about things that are specific to the business, such as marketing, historical mergers or acquisitions, personnel, or legal issues. Most of the time, this is not proprietary information, and the manager should be able to answer these questions or at least tell you how they are thinking about the issues.
For example, during a conference call on November 4, 2004, with a diversified media company that owns radio stations, an institutional analyst asked if management had near-term plans for format changes at its radio stations. Management responded by saying,
“. . .we don’t disclose any format changes that we might employ in our radio division. I’m sure you understand.” In fact, this is not proprietary and is one of the most important components of a radio company. If management does not want to answer questions about the most important part of its business, investors should view management’s actions as a warning signal.
In many cases, you will find that the managers respond to questions, rather than answer them. In other words, they will respond to the question with a statement that has nothing to do with the question, but it makes the manager look as if he or she is answering the question.
For example, one CEO was asked why the margins of the business had dropped, and he went into a long discussion on how the world was quickly changing around him and said that the economy was uncertain. The CEO could have at least explained that margins dropped because the cost of materials had increased, which was the real reason for the drop.
The first part of the call is usually filled with the CEO or CFO reading from a script that has been prepared in advance. A lot of time on the conference call is spent on this part, and I sometimes think that management does this in order to limit the question-and-answer period.
For that reason, I prefer to invest in businesses such as Penn National Gaming, which skips the script and jumps straight into questions with a few prepared remarks. Peter Carlino, CEO of Penn National Gaming, says “I find most of my shareholders can read, so I believe it is best to spend more time answering questions than reading a script that is found on the company website.” Over the years, managers have started to remove these scripted sessions from their conference calls to allow more time for shareholders to ask questions. This is an extremely positive sign because it indicates that managers want to address shareholder questions or concerns. They understand that shareholders receive the most valuable insights during the unscripted format.
For example, in an August 2010 conference call, clothing retailer Urban Outfitters announced that it would release a detailed management commentary so that its earnings call could be more focused. Similarly, in July 2010, disk drive manufacturer Seagate and biopharmaceutical company Gilead Sciences both announced that they would start reducing the time spent with prepared remarks on conference calls, instead posting those a couple of hours before the call so investors would have time to absorb the information and formulate questions. These are all positive signals that management is open with shareholders.
The following sections discuss some questions you can ask to better understand how managers communicate with stockholders, customers, employees, and suppliers: How do the managers communicate when confronted with adversity? And does management only emphasize good news in their communications?
How Do the Managers Communicate When Confronted with Adversity?
The best managers to invest in do not make excuses as to why they cannot communicate with customers, shareholders, employees, or suppliers when they are confronted with adversity. Instead, they communicate openly when the economy is in disarray or competitive pressures are high. In contrast, the worst managers to partner with are those who engage in face-saving behavior when confronted with problems. They usually turn to heavily lawyered news releases that do not address the issues, and they dance around the information instead of being forthcoming.
When Howard Schultz, founder of Starbucks, returned to the company in January 2008, he found that problems both inside and outside the company were causing sales to decline. Upon returning, Schultz promptly stood up to his 180,000 employees and their families and admitted that he had failed them. He told them, “Your leadership has failed you, and even though I wasn’t CEO, I have been around as Chairman. I should have known more. I am responsible.” Schultz said that once he did this, it was a powerful turning point for his company because the burden was off his shoulders, and he could now move forward. In an interview, he said, “You have to be honest and authentic and not hide. I think the leader today has to demonstrate both transparency and vulnerability, and with that comes truthfulness and humility and obviously the ability to instill confidence in people, and not through some top-down hierarchical approach.”15
Does Management Only Emphasize Good News in Their Communications?
You need to determine what information management emphasizes. For example, in the 10-K, there is a section titled “Selected Financial Data.” This is a pro-forma statement that condenses the income statement and balance sheet. This is where management highlights certain financial items it finds important, such as earnings before interest, taxes, depreciation, and amortization (EBITDA) adjusted for some type of charge. This section may give you some insight into management regarding what it reports and doesn’t report.
For example, Internet company InfoSpace, one of the few profitable dot-coms (according to its pro-forma statement) during 2000, reported that it had earned $46 million in pro-forma profits during that year. Naveen Jain, then CEO, was touting the stock on CNN’s financial network in late 2000, proclaiming, “Our wireless business is on fire!” The truth was that by GAAP standards (instead of pro-forma), InfoSpace lost $282 million in 2000. But the CEO was emphasizing pro-forma targets, which did not realistically represent the true earnings of the business. Eventually, InfoSpace’s stock cratered, and a dollar invested at its peak price was worth only three cents by 2005.16
The following sections discuss some questions to ask yourself as you either listen to or read what a manager says:
Is the manager easy to listen to?
Do you learn from the manager?
Does the manager use corporate speak?
Does the manager use double speak?
Is the Manager Easy to Listen to?
Chris Lozano, who was an intern at my firm, attended a lecture at the University of Texas at Austin with talks given by two entrepreneurs. One was the founding partner of a venture capital firm and the other was the founder of Southwest Airlines, Herb Kelleher. It was an interesting contrast according to Lozano, who said the venture capitalist was talking to the audience, whereas Kelleher was engaged in a conversation with the audience. Lozano said, “When I listened to the venture capitalist, I felt like I was having a boxing match with him.” If you find it difficult to listen to managers or read what they write, then it is likely a warning signal.
Do you Learn from the Manager?
After you’ve read or listened to what managers say, ask yourself if you are learning more effective ways to run a business from them. For example, when I was analyzing retailer 99 Cent Only Stores, I learned a lot about the retail business through both Dave and Sherry Gold, the founders. Their teachings enhanced my understanding of the fundamentals of running a successful retail business. On the other hand, if you find yourself wanting to teach a management team how to run its business, this is probably a signal that you have run into an incompetent management team.
Does the Manager Use Corporate Speak?
Many managers use corporate speak or make generic statements. You may often find yourself running two conversations in your head as you try to discern what they mean. Ask yourself, “Do they use a lot of corporate jargon such as the word strategic or thought leadership”?17 This may indicate that these managers do not truly understand their business and are more concerned with showing others how smart they are. When managers use corporate jargon, it may be that they are more interested in self-promotion than in clearly explaining to shareholders how the business is operating.
Does the Manager Use Double Speak?
Double speak is when someone says contradictory things, such as “We don’t time the market, but we will continue to hold cash until after the middle of the year, when things might get better.”
For example, the CEO of Reuters, Tom Glocer, once said this in a statement to the company: “Above all else, we acknowledged things would be tough in 2005, but we confidently set a budget that shows Reuters growing our revenues for the first time in four years.” Reuters then added that it was not issuing re
venue guidance in the memo, which had been released to staff earlier that week. The statement said, “This statement is not meant to imply that revenues will be positive for 2005 as a whole. The 2005 budget is not yet complete, and no revenue guidance has been issued for 2005.”18
Here’s another example: Griffin Mining, a zinc miner, disclosed on February 21, 2006, that “operating costs were higher than envisaged due to inevitable initial teething problems in commissioning the plant.”19 The key question you should ask is, if the teething problems were inevitable, why weren’t they in the budget?
And another example: At a conference on October 3, 2001, Joseph Nacchio, CEO of Qwest Communications, stated that instead of trying to convince the audience that Qwest was doing well, he would “just let the numbers speak for themselves on October 31.” When October 31 came, the company missed expectations, and Nacchio stated, “Some of you will recall that at a recent conference I said the results will speak for themselves. The reality is, they do not speak clearly for themselves without some interpretation, given the current economic conditions and the effects of merger and other one-time charges.” Nacchio quit in June 2002 amid an SEC probe into alleged accounting manipulation.20
The Investment Checklist Page 33