On The Perils Of Management Access & Straying From Process: Our Adventure With Jones Soda by Jordan S. Terry, Stone Street Advisors

Summary

  • We initially were skeptical about Jones Soda (JSDA) due to declining and generally weak financials, questionable strategy, and uncertainty surrounding its turnaround plan.
  • After the annual meeting and a one-on-one with the CEO (& CFO), we became convinced the company was in capable hands, and the turnaround would go well.
  • Turnarounds are hard, particularly for severely resource-constrained firms. We now believe Jones Soda should put itself up for sale rather than wait/hope for a small miracle.

Introduction

In late May 2013, we started working for a client who was interested in knowing what we thought about Jones Soda (OTCQB:JSDA). It was a bit of a treat to be able to work on a company whose products I had enjoyed so much during my more formative years, and it provided me the opportunity to do a lot of work that I don’t often get asked to do, some banking and activism stuff in addition to research.

Unfortunately, until very recently, I was bound by a non-disclosure agreement, which prevented me from sharing further analysis publicly. Now that I’m at liberty to write again, I want to discuss how we got the bullish call wrong in June 2013, what happened when we realized we were wrong, what we’ve learned in the process, and what we think about Jones Soda today.

I’ve tried to be brief, but since there’s a lot of relevant background information, this isn’t exactly a quick read. If all you care about is our current view on the company, you may skip to the last section, though you’ll be doing so at the expense of understanding the bigger picture.

A Good Analyst is a Skeptical Analyst

First off, for those unfamiliar with our firm, it’s important to note that we begin and conduct our research as skeptics first and foremost, no matter how excited we get over a growth story. To be clear, we are neither cynics nor permabears, far from it! Being a skeptic isn’t the same as being bearish; it means we seek to analyze firms without bias, positive or negative. This has allowed us to avoid many traps, both long and short, though we’ve certainly made some mistakes, and our take on Jones Soda was one of the worst.

So, why are we skeptics? Some, but not all of the reasons:

1. Most people err towards optimism rather than pessimism; virtually no one wants to talk about how a company is terminal, but almost everyone wants to talk about the next big thing.

2. Most investors are long and thus biased towards optimism.

3. Most analysts are directly or indirectly incentivized towards being bullish rather than bearish, leading many to downplay the risks and focus instead on the upside.

4. Management knows more about the company and its outlook than we do, and short of outright lying, will always paint their company in the best possible light.

Skepticism, then – the foundation of our research process – acts as a balance against the myriad bullish biases in the market.

A Skeptic Becomes a Believer: Takeaways from the Annual Meeting – May, 2013

Perhaps unsurprisingly, our initial analysis left me feeling pretty bearish. Revenues had collapsed, expenses were still too high (despite reductions), distribution too limited, and money tight. After a private meeting with the CEO, Jennifer Cue and CFO, Carrie Traner at the annual meeting, I left feeling pretty confident that the company was in capable hands and could turn it around with some common sense actions. On June 7th, I published an article on my erstwhile Forbes column explaining, at least in part, why we were bullish on the company.

As mentioned above, I walked into the annual meeting appropriately skeptical, with a legal pad of questions for management to address my many and myriad concerns. After the shareholder meeting and private discussion with the CEO/CFO, I left with a totally different opinion of the company and where it was headed than the one I’d walked in with.

Straying From Our Core Belief: Caveat Emptor

I have long held that “management access” is a slippery slope in the research game, though it is often touted as providing some sort of competitive advantage. We’ve generally been successful without the sort of management access some analysts are renowned for having, at least judging by the returns of our ideas and our hit rate. Due to Reg FD, executives can’t really tell you much they haven’t already said in a public forum, and if they do, they have to make that information public. They may provide some hints or answer your questions with some more candor/detail than on an earnings call, but I think these conversations are just as – if not more – likely to leave you with a biased view on the company rather than with additional, useful insight. Many will adamantly disagree with me here and/or dismiss my concerns for a number of reasons, but seldom, if ever, will an executive tell you the firm is doing or will be doing worse than expected. They have to be bullish on their own firms, so anything they say is naturally going to play-up the good and downplay the, shall we say, ungood.

Duh.

When it came to the meeting I had with Jones’ CEO and CFO, I violated my own philosophy of not taking management’s word at face value and allowed the experience to affect my judgment, instead of retaining a healthy dose of skepticism. Unfortunately, this was a lesson I’ve had to learn the hard way. This is not to say you can’t talk to management or buy what they’re selling; rather, you must take it with a proverbial grain of salt.

By mid-June, I realized that I’d given far too much credit to Jones’ management, but unfortunately, I couldn’t share any of my work publicly due to the aforementioned NDA with my client.

Step One is Admitting You Got it Wrong

On 6/19, I received an “out-of-office” reply to an email I sent the CFO with some questions, informing me that she’d be out on vacation until 7/22. The #2 person in a company elbow-deep in a turnaround takes a five and a half week vacation during prime selling season? Are you kidding me?!?!?

This, among a number of other issues, hit us square in the face, and we went back and reassessed everything we’d done thus far. I did receive an email from CEO Jennifer on 6/20 in response to my email to the CFO to set up a time to talk, which speaks highly of her; however, many of our questions/concerns remained unanswered/unaddressed.

As a result, I sent the following to the CEO on 7/11:

Jennifer,

To be very clear, the following is purely on behalf of myself and my company, so please do not attribute my comments in any way to *redacted* or *redacted*. These comments/questions are purely my own as an analyst (one of the very, very few who actually has looked in-depth at the company).