In yet another sign that today’s exuberant market conditions are inducing some strange side-effects – to say nothing of the havoc wrought on value investors’ psyches – Sony Corp president Nobuyuki Idei was quoted calling his company’s shares ‘overvalued’ in a January 6 interview with Reuters. Investors began dumping the stock as news of the story started to circulate, and by day’s end Sony was off 20 percent from its all-time high two days earlier.
Idei is not the first high-profile executive to comment on valuations; Microsoft president Steven Ballmer and Berkshire Hathaway’s Warren Buffet are notorious for their conservative statements regarding industry or company-specific valuations. But despite the prominence of these commentators, few people on either the corporate or institutional side advocate that companies should comment on valuation. And that is to say nothing of the shareholder lawsuits companies open themselves up to, particularly in the US.
‘I’d say that communications and financial officers should stick to their jobs,’ says Paul Blalock, executive director of IR at Reston, Virginia-based Nextel Communications, a wireless services provider. He says the job of IROs is not to come up with a valuation for investors. ‘Our job is to guide them on the fundamentals. We’re not paid to complete the analysis, that’s for the buy or sell-side. Obviously, I’ll complete the analysis if I think it is favorable, meaning we’re undervalued. But everyone has their own view of valuation, and I think it’s wrong to talk down your valuation.’
For investors, particularly bargain hunters looking for cheap deals, the idea of a company talking down its own shares might seem alluring. JP Gulli, founder of Delaware-based SS Investor’s, an independent research company that recommends value plays, says he’d prefer it if all managers tried to keep shares in line with what they’re worth, but the reality, he admits, is somewhat different. ‘The fact is, investors are taking a chance at the current levels, and they have to suffer the consequences. I think the bottom line is, no, managers should not make public statements with regard to the value of their stocks. Such comments can unleash a snowball effect and end up taking down other stocks as well.’
High stakes game
But even if Idei could take back his comments – comments that Sony spokespersons in London and New York later denied he ever made – the scenario touches on the issue of guidance. Every day, companies guide investors toward an appropriate target.
Nowhere are the high stakes more evident than with the darlings of the new economy. Many of these companies have seen their share prices rise 200, 500, 1,000 percent over the course of a year, or even months, often with triple digit price-to-earnings multiples. For them, the tremendous volatility and sensitivity surrounding their shares magnifies the consequences of any guidance they provide.
‘It’s the same challenge whether you’re a big company or small company, fast growth or slow growth,’ says Catherine Peterson, vice president of IR and corporate development at Ariba, a company that went public in June at $23 and was recently trading at $173. ‘I spent six years at Oracle, which has a slower growth rate than Ariba, but it was the same challenge. You have to know exactly where real expectations are and where internal expectations are. That is the core of your job.’
Peterson points out that while the job remains the same, Ariba and Oracle pose different challenges in terms of IR execution. Oracle’s industry – software and programming – grows 10-15 percent annually, which means the margin of error for forecasting is narrow and more manageable. ‘At Ariba, we’re growing exponentially,’ says Peterson. ‘If you’re a smaller company like Ariba and in a healthy industry you’re more likely to beat your own expectations. It’s the responsibility of the company to figure out the best and worst case scenarios and to under promise and over deliver.’
The cost of conservatism
To under promise and over deliver, companies have to make sure investors’ expectations are not drifting into territory outside a given range. And yes, there’s a bit of guiding people to a more agreeable, and lower, target. ‘One of the only ways to gain credibility is by delivering the news, and doing it consistently by meeting or beating the expectations that are set,’ says Blalock. ‘Having the expectations set to where they’re meetable and beatable is not easy quarter-to-quarter. There are two ways of doing it: having great performance, and keeping expectations down.’
Colt Telecom Group, a six-year-old London-based telecoms company that has seen its shares rise some 200 percent over the last year, focuses on the job of running the business, rather than the stock price. ‘Our approach to the stock price is that it is what it is, whether it’s low or high,’ says John Doherty, director of investor relations at Colt.
But the company also does its fair share of guiding expectations lower. As Doherty notes, exponential growth in any industry eventually slows. Part of his communications effort, therefore, is reminding investors of this basic fact: ‘The sheer mathematics of the situation dictates that you can’t go on growing at such rates. So we might address that. It’s not a negative warning, it’s just stating the obvious.’
But if lowering expectations is the name of the game, it is also a dangerous game. Investors are always reading between the lines. There are rumors, for example, that Microsoft’s bearish statements about the technology sector usually occur just before the company is granting its employees options. Opportunistic executives are trying to get them priced as low as possible. It is simply a rumor, but it illustrates the power of perception.
‘By holding down expectations, you run the risk of losing your credibility,’ cautions Jamie Sandison, director of European equity at Edinburgh Fund Managers. ‘When management is persistently cautious, the market wises up to it. To be cautious is certainly laudable, but investors get fed up if they’re constantly led to lower numbers and the company comes in and consistently beats them.’
A bit of bravado
Of course, if you’ve listened to a conference call on earnings from any of the high-flying tech stocks enjoying a boom in business, you know they’re not afraid to point out their accomplishments – a form of future guidance in itself. Sandison doesn’t fault such bravado, so long, he says, as companies quantify their success. ‘If a company’s profits are up 25 percent instead of 20 percent because they’ve managed to cut costs more aggressively than they anticipated, that’s something within their control, and that’s something they should be proud of. But if it’s because demand has been exceptionally strong and the ordering pattern is a bit different – something they don’t have any control over – they should point this out too.’
Doherty agrees, noting that in the event exceptional circumstances have impacted a specific quarter’s results, he will spell out those circumstances to allow the market to take that information into account for future forecasting. ‘There are simple things that have an impact, like the number of working days in one quarter relative to another. The reality is, these things have to be continuously pointed out to people.’
Dublin-based Baltimore Technologies, is a maker of e-commerce and enterprise cryptographic security software. It’s a company which conceivably could have become complacent, with a stock price on the London Stock Exchange that has risen over 900 percent in the last year. Its recent entry into the ranks of the blue-chip FTSE 100 – along with three other loss-making companies – caused a storm in the UK business media. According to Matthew Bowcock, Baltimore Technologies’ executive vice president of corporate development, backing up any bullish statement with quantifiable information became even more imperative last summer when the company prepared to list on Nasdaq.
‘One of the things we put a lot of effort into was developing very good internal forecasting and pipeline management systems. This is something that a lot of large companies have in place so they have predictability of their revenue, but it’s something often missed by a lot of technology companies. Unless you’ve got the systems worldwide down to the level of every single salesperson, all forecasting on the same sort of systems and the same sort of metrics, then you won’t know what your own position is and therefore have any ability to talk to anyone else,’ says Bowcock.
Lessons learned
While market superstars try to find a healthy balance between positive and negative comments, they have the luxury of tremendous performance. But eventually they’re going to disappoint. Doubters need to look no further than Lucent Technologies and Dell Computer, two companies that until recently enjoyed an internet IPO-like aura. But beginning on January 6, when Lucent warned that its fiscal first-quarter earnings would fall well below analysts’ expectations as a result of shifts in customer demand, the lights began to dim. Dell followed up with its own profit warning on January 26, citing parts shortages and a sales slowdown tied to Year 2000 fears.
While the examples prove that what goes up must eventually come down, there was a striking variation in the market’s response to the two stories. Lucent’s stock slumped some 27 percent following its announcement, shaving $55 bn in market cap off the company. In contrast, Dell fell just 7 percent. In fairness, Dell’s issues were easier to view as one-time anomalies – chip shortages and Y2K fears were prominent news items throughout the year – while Lucent’s problems were more complex.
But the issues of guidance and managing expectations were also a factor, according to Lawrence Serven, principal at The Buttonwood Group, a Stamford, Connecticut-based corporate research and consulting firm, and author of Value Planning: The New Approach to Building Value Every Day (John Wiley & Sons). ‘Both companies were very detailed in terms of explaining what happened. But Dell also explained what they were going to do to correct the problem in very clear terms. Lucent, by contrast, didn’t do as good a job of explaining how it was going to make up its shortfall over the course of the year. Dell had also done some foreshadowing earlier with analysts, where Lucent did less, so there was a major surprise factor.’
Although it might currently appear that young tech stocks are immune to such a scenario, some 40 percent of companies that went public last year are trading below their IPO price. ‘Even those in the dot.com world are busy managing expectations, some better than others,’ Serven says. ‘It’s still all about earning investor confidence that it’s your company that’s going to win.’
