Vertiv Holdings Co (NYSE:VRT) is currently defending two lawsuits alleging fraud – a class action filed in May 2022, and one acquired as part of the E&I Engineering deal. We address the latest filing from Vertiv’s class action fraud suit below. Prior to the company’s release of the 4Q22 results, we will publish an article illustrating why Vertiv’s margins are nothing but an accounting mirage.
Vertiv is fighting the fraud class action lawsuit we featured in our first write-up. Last week, the company filed their motion to dismiss the case signaling the inability of the parties to come to a mutually acceptable settlement. In our read, the motion is a weak defense. We suspect prolonging the action will result in a higher payout to the plaintiffs.
Q4 2022 hedge fund letters, conferences and more
Moreover, the defense illuminates a binary situation. Either management misled investors or it was completely unable to manage and forecast the business. Both impair VRT’s investment thesis.
A Low Key Management Purge
Our view of VRT as a deeply troubled company is supported by what appears to be a low-key management purge, as exemplified by exit of both CEO Rob Johnson and Chief Strategy and Development Officer, Gary Niederpruem. Half of C-suite managers do not leave healthy, successful companies.
The plaintiff’s allegations of fraud are built on the contradiction between management statements regarding actions to mitigate the impact of inflation during 2021, on the one hand, and management’s post-failure admissions and testimony from former employees on the other.
The defense discounts the compelling and detailed testimony of former employees by asserting that they were either ‘not in a position to know’ the facts, or made statements consistent with managements’.
The core defense is that management “did not make any false statements regarding its pricing response, because it repeatedly warned that inflation would outpace pricing power”, a statement that is contradicted by guidance of higher profitability. It further asserts that the plaintiff’s case is flawed because the risks to projections were disclosed, and that management statements cited by the plaintiffs constituted “classic forward-looking projections” and opinions, and do not rise to the level of fraud.
The presentation of risk disclosures as a mitigant strikes us as weak and disingenuous. The defense does not address the fact that management repeatedly assured investors throughout the year that higher profit margins were forthcoming, which is central to the allegations. Profits could not materialize without raising prices in excess of cost inflation.
The defense implies that despite management’s aggressive assurances, investors should have weighed the risk disclosures more heavily. As an investor, it reads like a caveat emptor - “we disclosed the potential points of failure and they all happened”, ‘you should have known’.
The most problematic defense assertions, in our view, involve what are deemed management’s forward-looking statements and opinions around their actions to ‘get price’. The amended complaint is littered with numerous statements that appear to be plainly false and or misleading. However, one exchange noted by the defense strikes us as particularly damning.
False And Misleading Statement
On November 16, 2021, Gary Niederpruem spoke at an investment conference and stated that “we’re going to get a year’s worth of price in just the fourth quarter.” The plaintiffs cite this as a false and misleading statement. The context in which it was made is critical.
Mr. Neiderpruem was attending a conference for institutional investors along with VRT’s CEO and CFO at the end of an exceptionally difficult 2021 in which pricing and margins were critical problems. The conference took place mid-way through the fourth quarter for which management had provided strong profitability guidance reliant on pricing power to generate margin.
VRT’s management team assured investors of their ability to mitigate the impact of inflation in an exchange spanning numerous questions focusing on pricing. Pricing was key because, the company’s profit margins had been squeezed and restoring them would take pricing power. Illustrating the exchange, CEO Rob Johnson stated “as inflation continues to rise…we’ll continue to take pricing actions. So, whether we’re here in Q4, we continue to take actions.”
Mr. Niederpruem’s statement was the crowning culmination of a longer discussion where management made a strong case for the company’s ability to ‘get price’ in the current quarter and beyond.
Investors would likely have taken Mr. Niederpruem’s statement in context to reflect positively on the current quarter. This is particularly likely given at the time VRT management would presumably have numbers for half the quarter and a strong view as to final results. The actual results were exceptionally poor.
The quarter closed 6-weeks after VRT’s presentation at the conference, and when reported on February 23, 2022, the company missed 4Q21 adjusted operating profit and free cash flow guidance by a staggering -47% and -89%, respectively. The horrendous results showed VRT did not get price in any meaningful sense–precisely the opposite cost inflation dramatically outpaced pricing.
VRT’s defense takes Mr. Niederpruem’s statement out of context and claim that VRT generated $28M of price in 4Q21 versus $20-25M in previous years. As such, his statement was true. That said, management would have known the current quarter was a disaster. In this context, the one-dimensional, unabashedly bullish presentation was a misleading bait-and-switch to the investment community.
The judge will decide if the defense is legally effective, but we think it borders on the absurd. It focuses on an element that could be construed to be technically true if viewed in isolation, though it carried an entirely different meaning in the context of the wider discussion.
It is highly unlikely that any investor at the conference would have interpreted Mr. Niederpruem’s statement to mean the company had a very successful ongoing pricing campaign, but at the same time could have a catastrophic earnings miss due to the lack of pricing power relative to costs. This is, essentially, what the defense asserts.
Mr. Niederpruem’s statement encapsulates the case as a whole and what we view as a fundamental problem with Vertiv. There are two options: either the statement was made to intentionally mislead investors or he was profoundly out of touch with the company’s operating performance late in the quarter that he actually believed what he was saying.
From an investor’s perspective, it doesn’t matter which. In our opinion, both impair management’s credibility beyond reasonable doubt.
Both Mssrs. Niederpruem and Johnson feature prominently in the lawsuit as key protagonists promoting the alleged fraud. Interestingly, neither executive remains with the company. Rob Johnson retired, allegedly for health reasons. Gary Niederpruem seems to have exited quietly in 3Q22; we would be surprised if it were voluntary.
We think it is a mistake for Vertiv to continue to fight the lawsuit as the lack of a convincing rebuttal will likely increase the settlement price tag. Further, the transparency afforded by further information does not exonerate the company, in our view. Rather, it reinforces the compelling case built by the plaintiffs and our view that VRT is a deeply troubled enterprise.
Dalrymple Finance
