In some ways Northrop Grumman presents a big challenge for investor relations. A year ago Northrop completed what amounted to a hostile takeover of Grumman, which had agreed
a merger with Martin Marietta. Both companies’ businesses were concentrated in the defence sector which, although it was holding up much better than anyone expected in the post Cold War environment, was no longer quite the ready cash generator it had been in the glory days of Ronald Reagan.
In addition, a Congressional General Accounting Office report was devastating in its criticisms of Northrop’s controversial and expensive B2 stealth bomber, which it claimed was overpriced, underperforming and not in the least stealthy. Add to that the concerns of some ‘ethical’ investors and a reluctance by some investors to put money in defence stocks for business reasons, and there are many reason why an IR officer could have a hard time.
But one thing that every analyst we spoke to agreed about is that 49-year-old J Gaston Kent Jr, Northrop Grumman’s investor relations officer, is outstanding in the field.
Fidelity’s Bill Rubin describes him as ‘always available’. Byron Callan of Merrill Lynch says: ‘Gas is exceptionally helpful, and has more exposure than most. He returns calls within a day even if he’s travelling, more likely within 12 hours.’ And George Shapiro of Salomon Brothers concurs: ‘They do an effective job and Gaston Kent in particular does a good job – he’s very knowledgeable.’
It’s all high praise for someone who says he ‘had to learn how to spell investor relations’ when he landed the job three years ago. Now on the board of his local Niri chapter, Kent clearly learnt fast, as evidenced by the analysts we spoke to (see box). And the number covering the company has grown, too. ‘When I started three years ago, there was no IR person, and we were covered by six or seven analysts,’ Kent says. ‘Now out of the 17 possible, 13 or 14 of them cover us.’
Kent may have been new to IR back in 1992, but he wasn’t new to the business. He had been in management with Northrop on the operations side since 1974 and claims his volunteering for the IR job reflected the spirit of the Alamo joke where the commander asks the volunteer to step forward, and the other 73 take one step back.
His new role was not made any easier by the fact that there had not previously been any such department, but Kent’s not complaining. ‘Now I’m actually doing it, I absolutely love the job,’ he says. ‘There’s no science to this. It’s a matter of building relations, of personal credibility, company credibility. In fact, it’s an art.’
As a USAF officer for six years he was in procurement, and complains that because of his eyesight he was not allowed to fly. Now he can identify targets, blast-fax, go one-on-one and have all sorts of sublimation in the new job.
It does help, of course, that Northrop Grumman has a healthy balance sheet and a secure order book. Even if the current contract for 20 B2s is not extended the effect will be, says one analyst, ‘Just to change it from a six billion and change company to a five billion and change company.’
Having a department of one does streamline bureaucracy, but Kent stresses that, ‘I don’t want to be presented as Mr IR. I am not IR. I am just the medium. The CEO Kent Kresa and CFO Richard Waugh are the IR; it’s my task to help them get the message across. Between us, our job is to keep the stockholders happy. And of course to let them know the stock is obviously underpriced.’
Kent reports directly to the CFO. ‘But I also communicate directly with the CEO and the board. We’re a relatively informal corporate office, and if anything comes up in analysts’ reports I take it to them immediately. The department is part of the CFO’s budget but, despite his reputation for openness with analysts, no figures are available on this: ‘We haven’t divulged it,’ says Kent.
The IR department also works closely with Jim Hart and the group’s public affairs department, ‘So that we all sing from the same hymn book,’ says Kent. ‘Of course, we strategise more on the financial side and IR tends to concentrate on the institutional investors. But public affairs and IR functions do overlap so we discuss what’s important and how to present things.’
The company has recently had two potentially serious IR problems, from both of which it emerged with some grace. On the Grumman merger, Kent says: ‘One major problem was educating the existing investors, who are always sceptical of mergers. This was not just in the public media but also one to one with both investors and analysts. We had a conference call with all the analysts and stockholders, and then we went on the road to Boston and New York,’ he explains.
From the audience side, Byron Callan of Merrill Lynch confirms the initial scepticism. ‘There was some concern at the time that the deal was overpriced,’ he recalls. ‘But the performance of the stock price since then shows that the market has more than accepted it now.’
More recently Northrop Grumman had to explain what appeared to be a 20 cent per share drop in earnings in the third quarter of 1995, as a result of the merging of the group’s pension plans. Kent explains that Northrop had a ‘more than adequately funded pension plan’, but that Grumman’s was neutral. ‘We merged the pension funds so that the effect was to lower our apparent earnings,’ he says. ‘In fact, in the long run it was beneficial since it meant that we didn’t have to fund the Grumman pension fund. It makes us more competitive.’
But that was never going to be easy to get across. When the quarterly results were announced, Kent and CFO Richard Waugh held a conference with 30 analysts in New York, trying to explain an arcane accounting issue that was not readily apparent to most of those attending.
In Kent’s terms, ‘It was tough, but it seemed to allay fears.’ And from the other side, Fidelity’s Bill Rubin comments as follows: ‘On the pension issue, they did a very good job of explaining a very complex issue. But even so, a lot of people were perplexed. Maybe they should have tried to explained it on one page?’ Crises apart, Kent’s main day-to-day responsibility is to analysts and institutional shareholders – a group that is usually assumed to cover most of the company’s stockholders. Kent warns against this, however: ‘That’s a bit misleading, since 28 per cent of the stock held by ‘institutional’ investors is actually in our own employee pensions and savings plans. They are handled by employee communications, but we make sure that internal publications carry articles about the finances.’
A further 54 per cent of the stock is in mainstream institutional investors’ hands; and the rest is in retail hands. Kent concedes that this latter group inevitably gets less personal attention and notes that they also tend to be more influenced by public media. They are less likely to be expecting shareholder perks: there are no grannies wandering off from Northrop Grumman annual meetings with free samples of F18 fighters in their handbags. ‘I think the cheapest item in stock is $30,000,’ he laughs.
Does the balance of institutional, employee and retail shareholders at Northrop Grumman benefit price stability? Kent says he is less scared of volatility than some: ‘But I prefer a balance,’ he says. ‘If everyone is a long-term holder then there’s not much stock activity. Pension plans generally tend to be inactive investors.’ That’s been true of the notoriously activist Calpers, amongst others: ‘We’ve kept them happy,’ says Kent. ‘And so far they haven’t been to see us,’ he adds laconically.
Although the company’s shares are not listed outside the US, there are some foreign stockholders – under 5 per cent – most of them in the UK. Kent says there is no company policy to try to attract, say, French investors, following a recent major half billion dollar contract from France. ‘But we do like having our name known,’ he adds.
For targeting potential new investors, profiling existing ones and for stockwatch, Kent makes use of the services of the Carson Group in New York. ‘They have a targeting programme that they call shareholder emulation and I call Chinese engineering,’ says Kent. It checks the profile of stock holdings of institutions and suggests suitable cases for targeting with a numerical rating. ‘I find that much more intellectually intriguing than approaches like, These people own your rivals’ stock so you should go after them.’
For almost all companies and industry sectors, there will be some classes of investor whom it’s simply not worth trying to woo. This is more true of the defence industry than of many other sectors, but Kent accepts that state of affairs with equanimity. He says he does indeed have questionnaires sent to him by ethical investment funds: ‘And I always answer them,’ he claims. ‘Of course, from our point of view, defence is the highest ethic. We believe in what we do.’
However, he accepts that some investors just don’t like defence stocks because of the inflexible returns. ‘Our numbers are lumpy,’ says Kent. ‘There are no straight lines, as with a consumer goods company. Before the merger, I remember being asked what our top ten product lines were – and I could only think of three. Now there are more than 20 of them.’
Kent is happy with the ‘lumpy but secure’ characterisation for the company’s products. ‘We have products with a life of 20 to 30 years,’ he explains. ‘And we are not just military. On the civilian side we are the biggest subcontractor for Boeing, with the 747 to 777 range. Our product base is stable, with little downside risk. Even the B2 is under contract for 20 planes. With the B2, I just keep them informed about what’s going on and try to keep analysts from including it in their future projections.’
That’s good news to the analysts we spoke to, who – while admitting the strength of the company’s Congressional lobbying efforts – would not bet their shirts on more orders for the controversial bomber.
The products emanating from Kent’s department at Northrop Grumman may be less controversial than B2 bombers but the IR effort has been innovative in its presentation over the past twelve months. Following the success of last year’s pilot, this year’s annual meeting was presaged by a video called Perspective 95, whose premier audience was the financial market.
Produced in-house in collaboration with the public affairs department, the video features shots of swooping aircraft with comments and explanations from the talking heads of the company, including CEO Kent Kresa. It is deemed a success, although Kent recounts a story that may tell us as much about the social life of members of New York’s financial community as it says about the success of the video. He says that one analyst called him from New York just before midnight to ask him a question about the video.
Another innovation this year is the Northrop Grumman Review, a glossy, well-designed quarterly magazine. Although aimed at a general audience of stockholders, this has a heavy financial input. Indeed, it was intended in part to replace the quarterly report, which Kent describes as a ‘useless document’ and which the company stopped distributing this year. Any shareholder with an information deficit can still call an 800 telephone line to get a fax of the numbers, but Kent certainly wouldn’t do anything that might encourage excessive preoccupation with quarterly numbers, especially for a company like his. ‘I do try to keep the analysts from being too concerned with quarterlies,’ he says. ‘After all, the quarterlies are not that significant – we are a long-term company.’
Northrop Grumman gave in to the modern way last year when it began to use conference calls, but Kent’s unease leaks through. ‘It’s like a press conference,’ he says. ‘If I were an analyst, I’d prefer to watch the speakers – to see the beads of sweat under questioning,’ he says.
In fact the team did try one video conference, but they found the equipment lacking. The pictures were jerky and out of sync with the sound, and the satellite link made it very expensive. ‘However, if it becomes better and cheaper then I can see the possibilities,’ admits Kent. But he confesses to a preference for one-on-one meetings with analysts.
The possibility of putting up a Home Page on the World Wide Web is also under consideration, and there have been plenty of offers from people wanting to do it for them. But Kent says people forget that these things have to be maintained and updated, which may not be an easy matter with a department of one. ‘We will probably get around to it,’ Kent says, but in the meantime releases go out on PR Newswire which is, of course, carried by several of the e-mail system providers. And, albeit on a slightly less sophisticated level, he invokes the company’s use of blast-faxes and faxes on demand.
In-house, Kent tries to second-guess analysts by using the valuation software that they use. ‘I try to reconstruct their models so that I can anticipate what numbers they’ll come up with,’ he says. On the other hand, the company does not offer up earnings forecasts on a plate to analysts. ‘We don’t predict earnings,’ acknowledges Kent. ‘We are more conservative than most.’
Analysts’ Views of Kent and Northrop Grumman
Byron Callan of Merrill Lynch begins by setting the industry scene but goes on to single out Northrop Grumman for special praise. ‘Like a hanging, the end of the Cold War concentrated the minds of the industry. They surprised a lot of people, generating large amounts of cash and becoming much more efficient, more mature, more effective. Their contracts are less onerous and risky. It was clear that business could not be continued as normal. As a result they are doing even better than in the 1980s.’
As For Northrop Grumman, ‘Its level of financial disclosure should really be a model for the rest of the aerospace industry. They just give out more numbers than anyone else, and provide more cashflow details than everyone else. It’s institutions that they’re focused on, the value investor, like most of the aerospace industry.’
George Shapiro of Salomon Brothers says of the company and its IRO: ‘They do an effective job and Gaston Kent in particular does a good job – he’s very knowledgeable.’
Fidelity’s Bill Rubin is not worried about Gaston Kent being a one man band. ‘In fact, if I found a company with more than one person in the IR department, I’d wonder about its priorities,’ he says. Rubin claims to be ‘very pleased with the level of detail given when they provide information about performance. And Gaston is always available, preparing for reports with conference calls and information.’
Rubin’s only quibble is about a matter that for Northrop Grumman is a matter of pride. ‘I’d have to say that he and Kent Kresa provide very little guidance on future earnings. It’s very general when it comes to profit, earnings and cost projections. If you ask the right questions, then Gaston will just comment that your suggestion ‘is not unreasonable’. As a buy-side investor we hold 7-8 per cent of Northrop Grumman stock.
When I looked at it a year and a half ago I thought it was a black box, worth no details. It wasn’t until I looked more closely that I saw its value. It has certainly been undervalued, with its strong performance. But since the whole industry’s profits are rising, I’m surprised that Wall Street is always surprised when the earnings go up.’
