When Management Destroys Shareholder Value – It’s No Better Than Theft
In the last decade we have witnessed the worst possible outcomes of company management committed to robbing their shareholders blind. With deliberate pretense the management of Enron, Tyco, Adelphia, and WorldCom sought to enrich themselves at the expense of their shareholders and their customers. While the CEOs and other senior management of these companies have exchanged their country club lockers for prison cells, their actions, driven largely by greed and arrogance, wiped out more than a $100 billion of investor assets and employee pensions.
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More recently, the same greed and arrogance, mixed with a lot of ignorance, led to the near toppling of our largest investment banks and banking institutions. Were it not for taxpayer bailouts and shotgun marriages, Goldman Sachs, Bank of America, Wachovia, Merrill Lynch, AIG, and Citigroup would have joined Lehman Brothers in the ash heap of Wall Street ruins. To punctuate their greed and arrogance, and flaunt their disregard for shareholders and customers, the senior management of these companies happily paid themselves record bonuses with the taxpayer bailouts. Because the activities leading to the collapse were not considered to be illegal, just ethically devoid, senior management not only escaped prosecution, they all walked away richer, while the share prices of their companies plummeted.
We may not see the likes of these horrendous corporate scandals anytime soon, but the lessons learned provide valuable tools for investors to evaluate company management. More companies collapse from management incompetence than executive greed, but the outcome is no less ruinous for shareholders. The recession took dozens of companies down. But many of the companies teetering on bankruptcy today are there because of ineffective management. The recent filing of American Airlines may seem to be business as usual for the airline industry (following the reorganizations of Delta, UAL, and US Air, however, the airline has been plagued by bad management decision for a number of years. More bankruptcies and stock collapses are on the horizon and most can be easily identified using three key criteria:
Deteriorating balance sheet: Mounting debt load, excessive goodwill and erratic or declining cash flow are the major red flags. A negative trending ROIC may be the first sign of trouble.
Zero moat: Companies with deteriorating balance sheets and diminishing competitive advantages are destined for disaster.
Inattentive (clueless) management: Many of the companies lost to the recession simply lost their capacity to innovate. One-product wonders usually don’t last, and the failure to develop innovative or disruptive production technologies will quickly fall to the back of the pack.
Strategic blunders: These usually result from a major management decision that diverges from core company objectives, and often result from the pursuit of short term revenue or balance sheet remedies.
Let’s try these identifiers out on a couple of companies that have abruptly changed their trajectory. Both were one-time high fliers with disruptive technologies and soon found themselves floundering among the also-rans.
Research in Motion (RIMM)
RIMM, once the leader in the smartphone market, has quickly become a textbook example of a company in stillness. Driven largely by management ineptness, the company has lost nearly $64 billion of shareholder value from its 2008 peak punctuated with a 71% decline in its stock price so far this year. Along the way it has managed to tick off its customers and its employees through appalling customer service and cost-cutting layoffs. Once it lost its leadership position to Apple’s iPhone, it has yet to develop an innovation that can possibly compete, and it is now threatened with bringing up the rear behind Google’s Android. It’s not that RIMM didn’t try, or that it didn’t have the technological capabilities, it’s just that they have always been a day late and a dollar short in their attempts. The most recent debacle was the introduction of their Playbook tablet meant to compete with the soaring Apple iPad. Not only did it wait until after Apple released its second generation iPad, it’s features and capabilities paled next to the iPad. The company recently took a $485 million write-down on its excess Playbook inventory. While it’s understandable that competing in a high-speed space is challenging, the sluggish response to innovation can only be attributed to the company’s leadership which has been accused making decisions based on strategic alignment, partner requests or legal advice. The co-CEO leadership of Mike Lazaridas and Jim Balsille has been distracted by a fight over control which has led to a consistent misreading of the market and a costly $250-million stock option scandal.
From the “what were you thinking” category, Netflix has emerged as the winner of the strategic blunder of the year award. Setting aside, for the moment, its decision to suddenly raise subscriber rates by 60%, the missteps that follow are bound to become legendary in business textbooks on “how to wreck a company in three steps.” Obviously the subscription increase ignited a firestorm of protest from customers, which, somehow the company didn’t see coming. Because, immediately following the uproar, it responded by announcing that it would separate its online customers from its mail-in DVD customers. That didn’t go over well, so it quickly reversed course and sewed them back up. Meanwhile, more than 800,000 customers bolted. To no one’s surprise, Netflix announced that it projected losses in 2012 after forecasting profits before its decision to increase prices. That led to Netflix having to go to the well to raise $400 million in capital which has further raised the consternation of its shareholders. The stock is down more than 60% on the year.
These are just two sterling examples of management incompetence that can destroy shareholder value almost overnight. Sadly, there are plenty more. I honestly can’t say which is worse – a deliberate fraud designed to rob shareholders, or the destruction of shareholder value through incompetence. The result is the same, so one cannot be any better than the other.