Tag: Boards

7 Rules for Keeping Activist Investors Away

7 Rules for Keeping Activist Investors Away

The following 7 rules apply to public companies across a variety of industries – particularly to Enterprise Software, FinTech and Information Services companies.

1.) Make Your Numbers

2.) Regular, Transparent Investor Communication

3.) Drive Expanding Operating/EBITDA Margins

4.) Don’t Stockpile Cash

5.) Control Waste

6.) Use Debt as a Tax Shield

7.) Board Composition – More Insiders

1.) Make Your Numbers: Always. At a minimum, it is imperative to meet the revenue and earnings guidance you have provided Wall Street. It is a bit of a game – we know. Making your numbers for 10-20 consecutive quarters doesn’t qualify you as a “great company”, simply as one that is adept at setting appropriately conservative guidance. However, try missing your numbers for 2-3 consecutive quarters. This is a surefire way to lose your CEO chair and to simultaneously put the company in play. Consider this table stakes.

2.) Regular, Transparent Investor Communication: Provide investors with measurable milestones beyond revenue and EPS targets. For example, if Company ABC has consistently invested 8-10% of revenue in Product Development each year for the past several years, investors would likely expect this to be the case for the foreseeable future. Should an opportunity present itself where the Company believes it to be in its best interest to accelerate Product Development to 12-13% for 4 quarters, the Company ought to frame the incremental investment in this manner for investors: “…12-13% Product Development investment to capitalize on XYZ opportunity which we believe will drive 2-3% incremental revenue growth in year 2 and beyond. This investment will be partially offset by holding G&A expense flat on an absolute dollar basis during the investment period. Net net, we anticipate $X dollars of pre-tax dilution which translates to ($0.01) EPS dilution for the duration of the investment period.”

3.) Drive Expanding Operating/EBITDA Margins: It is difficult to pick a fight with a company that consistently drives year-over-year operating margin expansion. But what to do when you hit the operating margin ceiling? Surely operating margins can’t expand in perpetuity. This is where a well-executed M&A strategy can provide a financial benefit – acquisitions provide companies with the opportunity to reset operating margins. IHS – now IHS Markit ticker “INFO” – was famous for this. For example, let us assume your operating margins are at 35% and you prefer not to take them higher as to do so would be to under-invest in the product portfolio. Perhaps there is a target acquisition that carries 15% operating margins. You believe that with scale and supervision the target company could achieve 30-40% operating margins over the next 3 years. Post acquisition close, depending upon the size of the target company, your corporate operating margins will fall below 35%. As you scale the acquired company and improve its efficiency, you will grow your diluted margin from its low point to something closer to 35% or higher. Thus, you can continue to tell your margin expansion story to investors.

4.) Don’t Stockpile Cash: Investors aren’t paying you to be a bank – particularly cash-rich Enterprise Software companies. How then to invest surplus cash? Hopefully as CEO organic revenue growth and product development excites you. Innovation ought to excite you. Technology companies are supposed to innovate after all. Innovation begets revenue growth which is re-invested in product development and the cycle repeats. Perhaps you have just completed an especially heavy innovation cycle and plan to limit product investment for the next 3-4 quarters. In that case acquisitions, dividends and share buybacks are three options for investing surplus cash. We prefer strategic acquisitions and dividends to share buybacks. Buybacks imply the company in question does not have a better investment alternative. This should rarely if ever be the case for a technology company. Think about it – in buying back stock you are giving shareholders who “want out” an out (I borrowed that comment from George Needham some 10-12 years ago).

SS&C Technologies (SSNC) and CoStar Group (CSGP) come to mind in terms of companies that have effectively used M&A to augment organic revenue growth.

5.) Control Waste: It is natural for the administrative state to want to grow. We see this with governments and with companies – especially at corporate headquarters. Former GE CEO Jeff Immelt used to travel with two corporate airplanes in tow – one for the business trip, one to shuttle him to his destination of choice post-business trip – this qualifies as waste. Current GE CEO John Flannery recently announced the company’s turnaround plan. It shrinks HQ and puts far more autonomy in the hands of the operating units. We are fans of decentralized operations when a company consists of multiple standalone business units. Give the business unit head the authority to run it as he/she sees fit. Let the business unit stand on its own two legs and be accountable. Accountability is a natural waste removal agent.

6.) Use Debt as a Tax Shield: This especially applies to cash-rich software companies. Why not shield a portion of your profits from the taxman? Take on a comfortable level of debt that you could repay if we were to have another 2008-like credit crunch. Interest expense is tax deductible. Plus, the additional cash could grow your M&A war chest.

7.) Board Composition – More Insiders: The trend that’s existed for the past decade or so is for the CEO to be the only Board insider and for the remainder of the Board to consist of outside Board members. As a result, Boards lack what I would consider a requisite level of industry knowledge and operational-understanding. Netflix (NFLX) has attempted to address this issue by having Board members sit in on operating reviews. My preference is to re-stock Boards with insiders. Not exclusively so, but approximately half of the Board ought to consist of insiders. Moral hazard you say? They’ll just fall in-line with the CEO? Well, if the company has compensated these insiders correctly, they’ll have substantial equity at stake. This ought to inspire them to call out the emperor when he/she’s devoid of clothing.

Our recent podcast on the subject:

Steve Jobs vs. Tim Cook – Innovator vs. Operator – It’s In Their DNA

Steve Jobs vs. Tim Cook – Innovator vs. Operator – It’s In Their DNA

Personality Analytics Holds the Key as to Why Apple Was More Innovative Under Steve Jobs than Tim Cook

Apple has lost its creative mojo under Tim Cook. Incremental product enhancements have become the norm, replacing a time when revolutionary new products, space age design and landmark advertising was the standard. What changed? Look no further than the CEO chair. Apple founder, CEO and creative genius Steve Jobs prematurely passed away in October 2011. Jobs’ hand-picked successor, Tim Cook, is by experience an operator with a background steeped in supply chain experience. Cook could not be more different from Jobs from a personality standpoint (see our table below).

The importance of assessing a CEO’s personality when conducting a CEO selection process (corporate boards, executive recruiters), or investment due diligence process can not be overstated. This is especially true of industry verticals marked by rapid change where the cost of having an ineffective CEO can be extremely high. It is not so rare to find a situation where a CEO, Board and institutional investor base were slow to realize that a given company’s customers were migrating elsewhere due to product obsolescence or other factors that ought to have been recognized. Few participants want to acknowledge this type of deterioration early or mid-cycle and only do so when it’s too late.

CEOs that create “adaptable” corporate cultures are less likely to lead companies that suffer irreparable declines due to product under-investment or other negligent factors. Adaptable cultures are less likely to be caught off guard and instead lead market change.

Corporate cultures are often an extension of the CEO’s personality. Yes, CEOs influence culture and corporate strategy even in mega-cap companies. Look no further than Microsoft (MSFT) during Steve Ballmer’s tenure as compared to Satya Nadella‘s time as CEO. MSFT’s product & services strategy is dramatically different as is the firm’s approach to competing and partnering with other technology companies.

We highly value the personality trait “openness” in large part because of its relationship to adaptable cultures.  Steve Jobs and Tim Cook score similarly on the openness scale – 92nd percentile and 94th percentile respectively. However, looking at the personality sub-traits under openness, Jobs scores far higher than Cook in the two most creative personality sub-traits: “artistic interests” and “imagination”.

Given that Cook lags in these areas, one would need to get comfortable with the idea that a non-creative personality like his (32nd percentile and 14th percentile as detailed below) is capable of generating massive creative output from Apple’s 120,000-plus employees. This is asking too much of Tim Cook in our view.  What doesn’t come naturally doesn’t come easily and may not come at all.

Our May 2018 CEO personality analytics research piece may be found here: Personality Analytics: Technology CEOs Analyzed

source: CEORater; IBM

 

 

 

 

 

Our recent podcast on the subject:

3 Rules for Tech CEOs

3 Rules for Tech CEOs

1.) Be Bold:

  • Similar to VCs, public investors want to invest in a bold vision. (See Tesla). Why does TSLA enjoy a premium valuation to other Auto OEMs? Answer: Musk’s vision and spin.

2.) Don’t Be Bullied by Investors  Dictate Your Story:

  • Tell the Street you plan to take margins down temporarily to pursue “X” initiative. Investors will cut you slack so long as you explain the rationale, the execution and the intended outcome.

3.) Balance Execution Today with Investment for Tomorrow:

  • Don’t fall into the short-term EPS growth trap at the expense of new product development, keeping your products fresh and building a culture of innovation.
  • If you pursue the short-term – investors will love you in the short-term (fleeting). The key is to build long-term value over years and decades (see AMZN, CSGP and SSNC as examples of the latter).
Your CEO’s Personality Influences His/Her Ability to Scale<span class="badge-status" style="background:red">Premium</span> 

Your CEO’s Personality Influences His/Her Ability to ScalePremium 

It is true. Your CEO’s personality influences his/her ability to scale (among other things). It may seem self-evident. One’s intuition may suggest such a relationship between personality traits and workplace effectiveness. Well, it is more than a hunch. Published research demonstrates a relationship between CEO personality traits and company performance. Gow, Kaplan, Larcker and Zakolyukina…

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We’ve Been Critical of Xerox Since 2012

We’ve Been Critical of Xerox Since 2012

We have been critical of Xerox’s (tkr: XRX) senior leadership since 2012 when I wrote a letter to former Xerox CEO Ursula Burns advocating a strategic M&A plan (read my letter here). We agree with Messrs. Icahn and Deason that XRX put itself up for sale. Listen to our recent CEORater Podcast on the subject: Ep. 114: We’ve Been On The Xerox Case Since 2012

Corporate Governance & Communicating Your Long-Term Strategy

Corporate Governance & Communicating Your Long-Term Strategy

BlackRock (tkr: BLK) is going “activist” within the passive investment (i.e. index funds) side of their house. Regardless of whether or not you agree with the approach (we don’t entirely agree with the social activist element nor the activist approach to passive funds) there is great merit to the idea of holding public company management teams and Boards accountable from a strategic, tactical, operational and general Corporate Governance standpoint.

Additionally, both institutional investors and company management teams need to do a better job of engaging one another. BlackRock’s Corporate Governance effort should be a catalyst to kick start a more substantive and frequent dialogue between institutional investors and public company management teams. For that, we applaud BlackRock.

We share our perspective on this matter in CEORater Podcast episode 111:

Further, here is Larry Fink’s open letter to CEOs and Boards: Read Here.

BLK
View BlackRock CEO Larry Fink and other CEO profiles at CEORater.com

 

Distracted CEOs and CEO Overreach<span class="badge-status" style="background:red">Premium</span> 

Distracted CEOs and CEO OverreachPremium 

We Have Entered an Unprecedented Era of Shareholder Tolerance It is interesting that corporate boards and institutional investors are willing to tolerate “Distracted CEOs” and founder CEOs who wish to exercise outsized control of the companies they founded. Both are examples of poor corporate governance. Our definition of a Distracted CEO is the CEO that…

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The Three “I”s for Selecting Board Members

The Three “I”s for Selecting Board Members:
1.) Intellectual Curiosity
2.) Industry Experience
3.) Inquisitive

ibm-booth

IBM lacks Board members that have Software industry experience other than CEO Ginni Rometty. We recommend that IBM turn over its Board and replace BoD members with new members who have significant Software industry experience given that Software – particularly a strategic M&A plan focused on Software/SaaS/AI/ML/Info Services acquisitions – is likely what will lead IBM out of its malaise. If IBM does not address its BoD and Executive shortcomings proactively it is probable that an Activist investor will make changes for IBM – with or without the latter’s consent. Click HERE for our CEORater Podcast episode concerning the 3 “I”s.

Senior Leadership Teams Influence A Company’s Success (or lackthereof) More Than Any Other Variable

 

Andy-Grove

For those whom don’t know, the photo is of late/great Intel early employee (technically not a co-founder) and former CEO Andy Grove.

What is the most important factor in identifying companies that will be successful over time? Answer: the senior leadership team.

Quality leaders should be offended when they are referred to as “managers”.  Effective senior leadership teams don’t “manage” – they “lead”.

Quality senior leadership teams have a greater influence on a given company’s success (however you want to define it) than any other one variable.

End market you say? Quality teams will capitalize on strong end-markets and have the courage to exit weak end-markets even when it may be politically difficult to do so.

Quality teams set the culture. Quality teams insist on hiring quality people and won’t sacrifice quality to satisfy a growth expectation.

Quality teams will push back on board members who have overly aggressive growth expectations that may jeopardize the company’s foundational core.

Quality leadership teams will pursue new, exciting product initiatives that have promise – even when data points and milestones are few during the early days of that product’s life cycle. Even when doing so may mean cannibalizing the core and pissing off investors.

Nobody said it was easy.