Blogging is going mainstream. Even Carl Icahn now has a blog. It is called The Icahn Report. He promises to share with us his techniques for unleashing value through good corporate goverance. I will add it to my blogroll and my google reader.
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(photo via flikr)
Jeffrey Immelt, CEO of GE, said this on the GE-owned CNBC television network.
“We hate disappointing investors. It’s not part of the company. It’s not part of the culture. We take accountability for that. This is something that we clearly didn’t see until the end of the quarter. What we did is try to reflect on that, not make excuses and take appropriate actions.”
This quote might have been around for a while, but I just saw it. It is powerful. It shows leading by example. Not much more needs to be said. Thank you, Jeffrey.
The expression “Investment Thesis” is an important one for private equity and venture capital investors.
The word thesis is defined as “a proposition put forward for consideration, especially one to be discussed and proved or to be maintained against objections.” Investment Thesis, by extention, means what an investor must believe for them to be comfortable that they are making a good investment.
Is Investment Thesis the same as Strategy? No. Strategy is a statement of what a company intends to accomplish. Investment Thesis is the rational that supports a belief that the Strategy is a good one and merits funding.
To launch Zayo Group, we needed to define our Investment Thesis. Investors certainly scrutinized it. If it didn’t hold up to this scrutiny, the company would not receive funding. On the next few posts, I will lay out our Investment Thesis.
Michael Wilson, finance chief at Envysion and winner of the 2007 Bear’s Den Texas Hold’em Tournament, solved the riddle. His explanation was succinct and spot on. I will simply post his response:
Saturday Night Live: Their debate parody “arguably” caused people to think about the treatment that the two Democratic candidates have received from the media.
The show benefits because they will have a string of shows from now to Pennsylvania that will be highly anticipated (and viewed).
You, like the rest of us, will benefit by getting to watch their comic genius at work.
I couldn’t find a YouTube post with one of their clips (BearOnBusiness.com readers: can you help?). Hillary did attempt to exploit the skits in one of the debates.
I received a spam email last week. Please read the first two sentences.
Do you find yourself with unused budget dollars, but you are running out of year? Freedonia has a couple of offerings which help you get the best value for your 2007 budget dollars.
Great idea. You didn’t spend all the money that your budget said you could. Party time. Spend it on something you don’t really need. Why not? Otherwise you lose it? This brought back bad memories.
Early in my career, I was with Ameritech (a RBOC which is now part of AT&T). Specifically I was with Ameritech Development, their corp dev arm. Sure enough, it was near year end in about 1990 and the senior management of Ameritech Development was giddy. “Order up whatever research reports you think you might want,” we were told, “we have surplus money in our expense budget. If we don’t use it, we lose it.” This came from 5th and 6th level management–for those who know the Bell system, this was very senior in the ranks. “Worse,” they explained, “if we don’t use our entire budget, our budget will be reduced next year.” They made it sound so horrible.
It seemed odd at the time–that is why I have a vivid memory of it. Money was spent only because there was extra money in the budget. I chalked it up to the monopoly and rate-of-return regulation roots of its heritage. I learned later that even competitive companies assume this mentality at times. The spam email I received confirms this mentality still exists.
So say me: If you have unused budget, DON’T SPEND IT. Instead, high-five your closest co-worker and send a note to finance letting them know they can shave a little off the budget for next year.
[Two blog entries from last week pertained to Salesforce Management Methodology. One of my very first posts in this blog pertained to the Importance of Predicting Cash Flows. An effective salesforce methodology is the crucial first step in forecasting financial results. To emphasize the relationship between last week’s two entries and my earlier post, I am going to re-print the earlier one here. For those who already have seen it, it is worth re-reading.]
Predicting Cash Flows: The Foundation of an Exceptional Company (from Nov 5, 2007)
The previous blog described the difference between “investing” and “speculating”. Investing is only possible if free cash flows can be forecasted with reasonable level of accuracy. Warren Buffett is an investor, not a speculator, so he only makes investments in companies whose cash flows he can predict with confidence.
A corollary to this principle pertains to how companies should be run. Management should make it an extremely high priority to build a strong corporate competence around how to reliably forecast cash flows. This capability should be an integral part of their culture. It should permeate the entire employee base. The goal should be to get better and better at both the thoroughness and accuracy of cash flow forecasting.
Further, management should involve the entire organization in this quest. The financial forecasts should be communicated often and in a way that makes it easy for executives and employees alike to understand. Every month, the actual results should be compared to the forecast. Was the forecast as accurate as it should have been? How could it have been more accurate?
Each month, management should update the forecast. The update should reflect that 30 days have elapsed and more is known than a month ago. Enabled by this new information, the revised forecast should be better than the old one. Moreover, if the company is getting better at projecting cash flows, this should be reflected in bettering the forward looking view.
I know what you are thinking: “your company already does this”. I doubt it, at least not anywhere close to the degree I believe it should. I am not talking about an annual budget process. I am not allowing for making loose approximations. If it feels like a bureaucratic waste of time, you can trust we are talking about two different things. If it is primarily an exercise for the finance organization, a warning bell should go off. If the balance sheet is excluded from the exercise, substantial pieces of cash flow are largely ignored. Finally, if the relationship between revenue, expense and capital is extremely hard to follow, know that your company is nowhere close to having a competency in this most critical area.
Buffett requires that he stay grounded in companies that he can reliably predict cash flows. Else, he is a speculator. Executives should require that their companies develop a core competency in accurately predicting cash flows. Otherwise, the executive is taking on more risk than he or she is required to. It is hard to overestimate the importance of this point. The executive cannot allow its employees to make decisions based on unnecessary speculation. The executive should not force investors to speculate on what should be knowable.
I feel so strongly about this point that I make it a centerpiece of every company I am involved with. We will be better at predicting cash flows than any company out there, whether in our industry or not. We will do this not just to be better than our competitors, as this is too low a bar in my mind. Our goal is to earn exceptional returns for our investors. Knowing everything we can know about our future cash flows is the foundation for doing this.
In subsequent blogs, I will discuss what management’s responsibility should be relative to its stock price. As a teaser, I will offer a provocative clue: the executive’s job should not be making the stock be as high as possible. This topic is very related to the one covered in this blog. Additionally, I will further discuss the concept covered in this blog, especially in the context of the great Telecom Boom, Bust and Resurgence.
In the prior blog entry, I shared thoughts on why we are dividing Zayo into three discreet businesses. The rest of this entry is a letter I sent to Zayo employees explaining the rationale. Note: this email was sent to employees within 10 days of the Zayo/Onvoy closing.
I know there is a fair amount of confusion of the three business unit structure. In the telecom world, people are simply uncomfortable with having separate businesses. Conventional wisdom is that it is more efficient to have one finance department, one NOC, one marketing organization. It seems nearly every functional person will insist that their group needs to look across the entire company.
Berkshire Hathaway is the most successful public company of all time. It is why Warren Buffett is the world’s 2nd richest man. They own multiple businesses. How many people work in corporate? Answer: a dozen.
“Yes but Berkshire is a holding company. They own businesses of all different types. That is why they are separate,” you might be thinking. “Zayo is different. We are one business.”
My answer: GEICO. B-H Reinsurance. General RE. National Indemnity Primary. U.S. Liability. Medical Protective. Homestate Companies and Cypress. Applied Underwriters. Central States. Kansas Bankers Surety. Lloyds of London.
What do these businesses have in common? One, they are all insurance companies. Two, they are run completely separate from each other, each with their own leader, each with their own accounting system, each with their own bank account, and each with their own IT systems. Three, they are all owned by Berkshire Hathaway.
Neutral Tandem just went public this month. The company, which was formed only a few years ago, provides wholesale voice services. Their revenue is about $70M. Their enterprise value is about $700M. Onvoy Voice has about $35M of revenue. To say I’d be pleased with a $350M valuation would be as understated as saying I’d be pleasantly surprised if, tomorrow morning, when I weigh myself like I do most mornings, the scale says 190 lbs.
Neutral Tandem doesn’t own any fiber; they buy bandwidth. They don’t provide managed services to enterprises; they focus on voice services to carrier customers. They have their own NOC; their own bank account and accounting systems, and their own customers. They have a clear business strategy.
What Neutral Tandem doesn’t have is a parent company that stands in the way of their ability to execute. They also don’t have to stand in line to get IT work done because the needs of other groups are a high priority. They will create value, or not, for their owners based on factors in their control.
Will Onvoy Voice have an advantage over Neutral Tandem because Onvoy gets to share a NOC, share a billing system and share a legal staff? I think not.
Substitute Cbeyond/Zayo Managed Services for Neutral Tandem/Onvoy Voice, the same points hold.
Zayo Bandwidth was the genesis of Zayo Group. Zayo Bandwidth’s path to value creation is to stay narrowly focused on being a bandwidth factory. Their implementation task is hard enough on its own; I do not want them bogged down by needing to coordinate systems, processes and corporate resources with two other business units. Over the past few months, I have seen several pure bandwidth businesses that are doing quite well—Hudson Valley Datanet, Fibertech, and Citynet’s Wholesale Unit in particular stand out. If Zayo Bandwidth does as well as these three, I will be thrilled. (Perhaps not as thrilled as if I saw 190 lbs on my scale, but pretty darn close.)
So there it is. That is why we are separating into three businesses. It is for this reason and no other: I want each of the three businesses to have a true leader, a clear strategy and the autonomy to execute their plan. I want each to be fairly judged on its financial results. I don’t want any of the businesses to be encumbered by being part of the same ownership group.
In the prior blog, I shared why I believe focusing on exit strategies can be very harmful to a company and its investors. Charlie Munger and Warren Buffett take this many steps further. They simply say that they are unlikely to sell any business.
Point 11 of Warren Buffett’s Owner Manual is: You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations.
Munger and Buffett have earned the right to take this position. They earned it because they have demonstrated year over year that Berkshire Hathaway is an environment in which businesses are run well. They create value for their shareholders. In most cases, a company is likely to perform worse if extracted from Berkshire.
What about a strategic buyer? Generally speaking, Buffett’s companies are either so big (making strategic synergies less relevant) or so unique (resulting in the likelihood a strategic buyer would screw up the franchise).
Also, Berkshire has created its own franchise about being a great long-term home for a business. A person who sells their business to Berkshire need not fret about a subsequent and disruptive sale. They need not worry about a strategic buyer messing up what is special about the company.
Berkshire is very unique in this regard. Let me repeat. They have earned the right to take this approach based on nearly 50 years of outstanding execution to be adamant about the philosophy.
“What’s the exit strategy?” Page 4 in the Venture Capital handbook. Page 6 in Private Equity Investing for Dummies.
I dare you to answer “Not only don’t I know, but I don’t particularly care either.” Don’t expect to get funded.
Which, come to think of it, leaves me a bit concerned. I wonder if my investors are reading this blog. This entry could be a bit of a problem if they are.
Warren Buffett says: “If you don’t feel comfortable owning something for 10 years, then don’t own it for 10 minutes.”
The Bear pipes in: “Getting Bailed out is No Exit Strategy.”
Mark Cuban chuckles: “Getting bailed out worked pretty darn well for me.” Cuban, the eccentric and free-wheeling owner of the Dallas Mavericks, sold his Broadcast.com start-up to Yahoo in 1999 for $5.7B. http://www.internetnews.com/bus-news/article.php/90621 Wall Street responded positively to the deal. Though Yahoo has done well over the years, this particular acquisition was something that they certainly regret. Cuban, who lives the life of a king, must laugh himself to sleep every night while pondering his good fortune.
I sold ICG to Level 3 in 2006. I did it because our investment group and executive team crafted a turn-around plan that suggested these properties would be worth more if they were part of a larger entity. I did it because our investors needed a big win (marked by a liquidity event) and because certain members of my executive team desperately wanted to put cash in the bank. I did it because recent meltdown memories (including just prior to us at ICG) included companies that began to show signs of turn-arounds (often through bankruptcy or debt restructurings) only to be faced with yet another crisis. In the back of my mind, I feared we might fall into the same trap.
At the same time, I was convinced that we were selling way below value. Hindsight is 20/20 of course, but I know now how right this conviction was. We sold ICG for $170M, resulting in a total exit of over $225M on our $8.7M investment.
Level 3 got a bargain for ICG. Our revenue was $80M and growing at 15%+ a year. Our EBITDA was $25M and was growing at 20% annually. Our free cash flow was $1M/month and growing. Our franchise was a vast and unique network in Colorado (and to a lesser extent Ohio)–replacement value was well north of $150M. Today, the business would have been generating $35M of EBITDA and have been valued over $350M. It pained me to let it go at the time. I pains me even more now.
This experience led me to better appreciate Warren Buffett’s frame of mind. I will chat more about this in a subsequent entry. For now, I want to emphasize why I think over-focusing on exit strategies is harmful.
Too often, in my mind, companies tailor their strategy to “how would buyer such-as-such value my business?” Or they look at others (including investors) and get enamored with eyeballs, seats, page views, clicks, lines, route miles, pops, or other potentially meaningless measures of value. My belief is that way too many executive teams (and investors!) unknowingly get confused between building a solid business with chasing the latest get-rich-quick trend.
Focusing on exiting promotes short-sighted behavior. It moves focus away from fundamental long-term decision making. It often tugs a company the wrong direction. It is why I now explicitly discourage dwelling on exit strategies.
I focus on the following: Do we have a solid franchise? If not, what one are we trying to create? If so, how do we make it stronger? How will this translate into predictable and abundant free cash flows? Let’s do all these things extremely well. Let’s not get all worried about how a strategic buyer or Wall Street analyst will value our company based on today’s metric-du-jour.
Do me a favor. Don’t mention this to my investors. They cannot help themselves: exit strategy is in their DNA.
Last week, I presented to a group of telecom and media professionals in Denver. The topic of the speech followed the theme of this blog: the “Great Telecom Boom, Meltdown, and Resurgence: What have we learned?” During the talk, I presented my four key management ethics (see “Ethics according the the Bear”). The first of my ethics is:
“Treat shareholders as long term business partners, and view management as managing partners. An enterprise must be managed with the perspective that investors (not management) own the assets contained within the company. It is management’s responsibility to ensure all executive compensation and perks are clearly understood and approved by its investors.”
In the Q&A, a person who identified themselves as a shareholder activist (I think) asked: what should be done about excessive executive compensation? Hmmm. Good question.
The first thing that crossed my mind was what should be done about how much money Scott Boros wants the Yankees to pay Alex Rodriguez? From my perspective, only the owners of the Yankees and A-Rod can answer that question. If by having A-Rod, the Yankees are no more valuable than without him, then (if profit is the motive) the Yanks shouldn’t pay him anymore than another decent third basemen. However, assume both the owners and A-Rod believe the Yanks are worth a lot more with the reigning MVP on the team. For example, if the the franchise is worth $40M more a year, should A-Rod feel guilty if he demands $20M a year? If ownership gets him for far less than $20M, the owners simply get to keep the delta for themselves. Would that make a shareholder activist happier? Not if the activist is trying to look out for the little guy. That is, A-Rod forging $10M of the $20M means is unlikely to mean the grounds crew will get a big raise.
So my answer was two-fold. I adamantly believe that it is a CEO’s responsibility to ensure his or her investors fully understand and approve executive compensation and perks. No fine print. No footnotes. No ambiguity. Please know that purposeful ambiguity regarding executive comp and perks was a huge problem in the telecom boom. Often this played out in the form of ridiculous severence agreements. To me, this is unethical. The CEO is responsible for being clear and complete in ensuring his or her investors understand all forms of executive pay. In public companies, this should be clearly communicated in annual reports and proxies.
So (assuming the CEO does a great job in ensuring his or her owners understand executive compensation) what is excessive? Let’s circle back to the Yankees and A-Rod. It is whatever the owners are willing to pay. Warren Buffett is extremely vocal in how rare, special and incredibly valuable a great CEO is. Such a CEO is just as entitled to his or her fair share of value creation as a great athlete.
With this backdrop, though, let me emphasize the following: investors took their eye way off the ball during the boom. Boards, in many cases, did not do their job. They did not represent the public shareholders (or their limited partners) suffiicently in negotiating deals. Often, board members let themselves be put in compromising situations. Boards allowed confusing and incomplete disclosures regarding perks and pay. Perhaps most sinful of them all, they did a poor job of distinguishing a talent akin to an A-Rod from a untested and unproven executive. They allowed ridiculous amounts of a company’s wealth to be paid to these unproven executives, even if performance was poor.
Blame the executives if they are not forthcoming on pay and perks. Blame board members if they do not manage pay and perks appropriately. Blame yourself if you invest in a company that appropriately discloses compensation but, at the same time, you think executive pay and perks are excessive.