Month: February 2017

Four thoughts on how to deal with Hedge Fund Investors

After being a public company CFO, I spent some time as hedge fund analyst. During that twelve years I spoke with a lot of management teams, watched hundreds of investor presentations and read a
roomful of disclosure documents.

The most interesting change in perspective was 1:1 meetings, when we’d be in a room with the CEO and CFO and we’d have an hour to ask questions. Sitting in those meetings on investor side of the table was a lot easier than being a CFO. However, the biggest difference in the two positions is time span.

When you run a company you are thinking about time differently than a hedge fund portfolio manager. Projects take years and to turn the ship is hard. Profitable business investments have to be identified, planned and implemented.  If you are a hedge fund manager, you can reshape your portfolio in an afternoon, and exit your positions within a week.

Elliot Jacques wrote about the “time span of discretion” which dealt with the time frame where the executive was focused. Most senior managers are focused on the coming 6-12 months. Most fund managers are focused on the next 2-3 months. I’ve argued before that senior management needs to raise its focus from making this year to a process of making every years’ numbers. Thinking further out will not help your discussions with a short term investor. I’ve come up with four ideas for you to think about when dealing with professional investors and the hedgies.

1)    Prepare your company presentation as a story.

Most stock analysts are intense, smart, educated and inexperienced. When they make mistakes it is usually based on relying too much on book learning and too much reliance on models. Most risk isn’t covered in an excel spreadsheet, and at best they generate a couple of point estimates for EPS based on simplistic assumptions. Their lack of experience makes them open to a good story. A well constructed narrative will sway an analyst, even if the story is simplistic and inaccurate.  Good stories have a beginning, a middle and an end. There are characters. A good story has a coherent theme and is easy to remember.

2)    Keep your messaging consistent.

Because analysts often lack the experience to tell if a management team can deliver, they simplify and judge on message consistency. If you separate a CFO and CEO at a stock conference and quiz them individually about recent events at the company, you will often hear two stories, which is a problem. If the words in the 10k don’t align with the slide deck then there is another inconsistency. Hedge fund analysts are a little more savvy, they are paid more and they have been burned a few times. They are less swayed by a story and are more tuned in to the results.

Off the cuff remarks and meetings at the bar are a danger to management teams.  I once heard a senior executive announce that they had to work the weekend on the budget. It was April. What does “having to work the weekend on the budget” mean in April? It means you are off plan.  Analysts are not your friends and there are no “off the record” conversations.

3)    Be prepared.

A management team presents the strategy to the board, to executive management, to senior management, to the employees and to the investors. If the investor presentation doesn’t sound practiced, then how much has management communicated to the company? If your presentation isn’t crystal clear, clear enough that a person with a high school education can understand, then you probably haven’t presented it the 20+ times you need to if you are going to convince the employees.  Repetition equals retention. Management teams that are not practiced fail. After valuation, this was my most reliable source of ideas. If I heard a management team stumble through the presentation of a complicated new strategy that would require thousands of employees to do something different (say make panini’s at Starbucks), I knew I had a winner short idea.

4)    Don’t take it personally.

A hedge fund trades in and out of stocks a lot. Selling your stock doesn’t mean they hate your company. It just means that they’ve found something that will move more or sooner than your company. We shorted a lot of good companies because we have to hedge our other positions, that is what we are being paid to do. I went to a lot of meetings without a preconceived notion of whether a stock was a long or a short. We’d be short for an event or a tough quarter, and then would go long.  Management teams that obsessed with whether the analyst is a “long” or a “short” wasted their efforts. Keep your ego out of it, manage what you can manage and make the company better.

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Dr. John Zott is the CFO for Carlson Wireless Technologies, and Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are a former student, colleague or would just like to connect – reach out.

 

Retrospective Thinking and You!

Santa Cruz Small Boat Harbor Lighthouse

McKinsey recently published a survey about whether CFO’s are ready for tomorrow’s demands on finance.  For the most part it is not terribly helpful.  The additional roles include the “new” fields of risk management and compliance.  These tasks have been with us for decades, but today there is a department with the title.  My experience with big consulting firms is that they offer good input at a high price.  (However, I read everything Tim Koller writes for McKinsey and you should too.  I’d classify his insights as great ideas.)

The CFO survey had one question about capital expenditures which caught my attention. Only 30% of the CFO’s agreed that their company “has a formal process to review investments made 3-5 years ago.”  This is a big problem as firms that don’t check on their performance don’t learn from their mistakes.  Retrospection is hard and I get why you don’t want to do it.  Ben Franklin said “Experience keeps a dear school, but fools will learn in no other”.   When a management team makes a mistake and doesn’t learn from it then we even less smart than the fools.

I know that everyone cares about the stock price.  Stock prices are driven by the return on investment in the projects the management team selects.  Poor project selection means poor investment returns and poor stock price performance.  Measuring returns informs future investments and identifies opportunities.  It creates accountability.  It is the difference between taking a class in investing and trading in the stock market for a living.  Great investors track their wins and losses and try to learn from both, although the losses are always the most informative.

After being a CFO I took a turn as a hedge fund analyst. About 10 years ago I went to a stock presentation where Coldwater Creek was touting their secondary offering. The plan was to open new units that would generate great returns, earnings and a high stock price.  The management team offered up very compelling ROI’s over their first three years of investment in a new unit.  I got to ask one question: “how many of these stores have reached their three year anniversary and did they perform similarly to the forecast?” The answer was they had no units that had yet reached the three year life.  I wanted a follow up question but the CEO wisely picked on another analyst.  Simply put a pro-forma financial model is not the same as actual results.  Coldwater Creek never achieved those planned returns and the $32 stock is now worth 2¢.

I worked with a major US bank and was told that the way to promotion was to make a lot of loans fast.  When inquired about what happens when they inevitably go bad, I was told that the rotations typically lasted 24 months, and the problems didn’t show up until after you’d left the department.  Credit problems were never tracked back to the initial bank officer, just assigned to the executive that then held the portfolio. The difficult job at the bank was in following one of these “fast-trackers” and constantly dealing with a crappy portfolio.  This strategy worked until there was a slow down in growth and executives were stuck in the job for 48 months. As Warren Buffett says “ Only when the tide goes out do you discover who’s been swimming naked”.

Recently I heard that the average Silicon Valley CFO lasts 28 months in a job.  I’ve never seen a financial analysis on a public company that didn’t go back at least three years if the data is available.  The analysis usually go back at least five years and I’ve seen some that go back ten years.  We do that to get a sense of how capital has been deployed though the firm’s history.  I’ve written here about how hard it is for senior executives to change a business model.  Returns on investment are persistent with companies generally moving towards the mean return for the industry.  Some of reversion is due to luck evening out, and some of the reversion is due to management teams responding to incentives, both bad and good.  If the management team knows that they will be held accountable for capital investments, they have a big incentive to do a better job.

I get that everyone wants to focus on the future and no one wants to poke through past errors.  As investors, we are relying on CEO’s and CFO’s to invest the assets of the company wisely.  As executives, that means taking a hard look at how capital has been invested, what we did wrong, what we did right and what that teaches us.

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Dr. John Zott is the CFO for Carlson Wireless Technologies, and Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are a former student, colleague or would just like to connect – reach out.