Monday, May 01, 2006
Free Ken Lay!
Former Enron CEO Ken Lay is, as we all know, on trial, and the big question the talking heads are debating is whether he has done himself any favors by testifying in his own defense. The consensus seems to be that he has not.
I agree with the consensus, although that question doesn’t particularly interest me. What interests me is precisely why Ken Lay is on trial.
I understand Jeff Skilling being on the stand—after all, he ran the joint while the Fastow deals were being concocted. But from what I’ve seen, Ken Lay isn’t accused of putting those deals together or managing earnings to meet or beat Wall Street targets.
As best as I can tell, Ken Lay’s alleged crime was deliberately misleading investors about the health of his company—giving upbeat public statements even as the business was falling apart. Sounds bad, I suppose. But when, exactly, did corporate spin-doctoring become a crime?
I am asking a serious question. Rose-colored glasses exist everywhere in corporate life as well as on Wall Street. Entrepreneurs and empire-builders tend to be optimists, not pessimists. They do not dwell on the negatives and they do not tend to naval-gaze. The type of brutal introspection and self-criticism spiraling through the DNA of Warren Buffett does not exist in most corporate genes.
Furthermore, calling the glass “half-empty” rather than “half-full” is certainly not in the economic interest of public company managers, given how closely tied to stock prices is corporate pay these days, thanks to lottery tickets known as stock options. This is particularly true when it comes to the kind magical lottery tickets the United Healthcare Board of Directors showered on their favored son—I’m speaking of stock options which appear to be retroactively granted to assure the beneficiary that he has already won the lottery.
But I don’t mean to single out United Healthcare. Has there ever been a company whose CEO emphasized the negative rather than the positive on an earnings conference call? Has any COO ever honestly admitted that he made an emotional decision to throw good money after bad on a stupid initiative, rather than blame its failure on unforeseen market changes?
Has any CFO ever rounded a number down instead of up?
I listen to hundreds of earnings conferences calls and management presentations each year, and I can count on one hand the number of companies whose top managers have gone out of their way to downplay good news or highlight bad news before it shows up in the income statement.
Wall Street loves “upbeat”—expects it, and punishes its absence brutally. For proof, check out Aetna’s ten-point collapse after last week’s less-than-upbeat earnings call.
It’s only human nature, then, that a CEO will do everything possibly to avoid the non-upbeat conference call. Heck, they don’t even like to take responsibility after the fact, let alone in real time, as the government appears to have expected Ken Lay to do.
For proof, look no further than the just-released General Motors CEO's shareholder letter, in which he resorted to the classic Nixonian “mistakes were made” defense regarding the multi-billion-dollar accounting error at GM. (I am not making that up: he actually wrote “errors were made.” You can read the full letter along with the proxy statement that reports his $5.48 million compensation last year.)
Thus, I am happy to report an exception to this rule occurred on a Friday morning conference call. That’s when my old Is-Naked-Shorting-Really-To-Blame? CNBC sparring partner, Overstock.com CEO Patrick Byrne, took full responsibility for the problems that have ensnared that internet reseller:
So to me, this is all a function of bad decisions I made in the first half of '05, both in that they were belated, and then I made a bunch of them and we tried to throw a bunch of stuff together, and we stumbled.
The rest of the call was not quite so straightforward, as I gathered from the instant-messages I received while the call was underway. Although I don’t listen to Overstock conference calls, I could tell it was a doozy, even by Patrick Byrne’s self-established lofty standards of dooziness.
Indeed, the transcript is one for the ages—here’s an actual quote:
It's funny that you ask that. We actually have a truck full of important parts trucking in through -- coming in from L.A. through southern Utah, ran into a cow and tipped over the cab, and that actually, literally, has stopped the project for two weeks. But short of any more cows on the interstate, I don't see how that gets delayed. That's just bolting things together.
I am not making that up. And there’s plenty more where that it from, but I won’t reprint them here, because, like all Byrne conference calls, the more outrageous he may sound, the more it masks the serious nature of the claims he makes, not just about his perceived enemies but about his business. Particularly the earnings power of that business.
One year ago Byrne addressed a question about when Overstock would be profitable by telling analysts that profits could come when the company slowed down its sales growth. Specifically, he said:
Well the answer to that is you tell me when our growth tails off. You tell me when we're not growing 100% a year and when we can't grow 100% a year and I'll tell you when our -- at what level we will show profit.
—April 22, 2005 conference call.
A few months later, Byrne returned to the subject with a bit more granularity, as the analysts say, and mused on what would happen to operating income as a percentage of sales if sales growth slowed to 15%:
I think it's a north of 6% operating income business if we're going to slow it down to 15%. If we're going to be slowing it down to 15% secular, I think that we can do north of 6% at this point.
—August 3, 2005 conference call.
Those were not the first times Byrne had addressed the issue, which is, after all, the key to any fast-growing business except, perhaps, Google, which has managed to maintain fantastic profits even while maintaining 100% growth rates. As early as 2004 he suggested the company didn’t need to slow growth in order to become profitable:
As far as the trade-off between growth and profit, I think that the absolute trade-off between the two is maybe going away. I think that we see--we seem to be reaching the point that--you know, I think with just a little bit more -- I'm optimistic that our -- that our losses may shrink or disappear while we continue this kind of growth. Or even accelerate. Okay? Next question
.—July 23, 2004
But I think that it's more prudent to say I see that Piper just came out with -- I didn't even realize we were talking to Piper and I'm thrilled that they picked us up. And they came out, I think they plugged 60% growth for the next couple years and that seems to me a prudent growth assumption. And then sort of how -- where the profits come out, I think we should be able to be profitable next year, certainly on a year basis
.—October 22, 2004
More recently, Byrne presented this tantalizing assessment of the web site’s earnings potential:
And he's back [Jason Lindsay]. He's actually sort of kept a toe in the water with us for the last couple of years, and he knows everything going on in the business. He's much more conservative than I am. I think he'd like to see us throttle back to 20% growth and start spitting out $40 or $50 million.
—October 28, 2005
Nevertheless, as reported on Friday, Overstock’s first quarter 2006 revenues grew at somewhat less than 100% cited in the April 2005 quote. They even grew less than the 60% cited in October 2004 and the 20% in October 2005 and the 15% in August 2005.
Overstock’s first quarter revenues grew 9%.
But the business was not profitable. Rather, the company lost $15 million, or 8.3% of sales. Operating cash flow, according to the CFO, was a negative $73 million.
How to reconcile Byrne’s comments on prior earnings calls with this year’s actual results was not specifically addressed on Friday’s conference call—at least according to the transcript before me—and remains unclear.
How to reconcile Rick Waggoner’s formerly upbeat assessments of General Motors with his “errors were made” confession is also not clear.
Nor is the line Ken Lay crossed in his upbeat assessment of Enron’s prospects, nor the management of any other public company where the glass is not, in fact, half-full.
I say, “Free Ken Lay!”
I Am Not Making This Up
© 2005 Jeff Matthews
The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.
Posted by Jeff Matthews at 8:11 AM