Sunday, February 7, 2016

Even the best fumble at times: Tips for handling an earnings miss

It’s been a rather bumpy earnings season.  Companies that made their estimates and offered reasonably positive guidance fared well, at least on a relative basis. Companies that hit their numbers but issued cautious forward-looking statements, were crushed in the marketplace; see LNKD or DATA.  Then there is MTCH, a company that missed top line expectations first quarter out of the gate; that is a little like making a Valentine’s Day reservation at a fine restaurant and failing to show up, leaving your date sitting alone. You've created a memory that definitely isn’t going away any time soon. Like, ever.

There is no way to insulate a stock from market swings. Results that might be benign in one market are miserably malignant in another. However, it is possible to minimize the damage, either in scale or duration and so, in the middle of this “earnings season”, we thought it might be useful to revisit some earnings release strategies.

Note to Recent IPOs: DO NOT MISS. Really. DO NOT MISS

When investors take the risk of investing in a new issue, an IPO, they have certain expectations about the “out of the box” performance of that company. First, investors expect the company to deliver results in-line or better than what the underwriting investment banks’ analysts forecast during the road show. It is no secret that analysts in the underwriting group receive detailed guidance from management and while from time to time an analyst will go rogue, in general the initial forecasts align closely, albeit in a conservative way, with management’s own projections.  A miss during the first 2 or 3 quarters suggests management’s ability to forecast isn’t ready for prime time.
 
In addition to hitting or beating analysts’ estimates, and really, “hitting” is the same as missing as all IPO prospects are
very strongly encouraged to launch with “in-the-bag” estimates, management of a newly public company is also expected to follow a strategy matching the one discussed on the IPO roadshow.  Public investors are right to expect that what they were sold on the IPO will closely resemble what will be delivered in the aftermarket.   Even the smallest variation from the model originally communicated can send investors racing for the exits and send the corresponding stock price into a nosedive.

Public investors are very different from VCs.  Sometimes, VCs can be forgiving, at least for a quarter or two, when something goes off track.  Public investors often will hit the eject button at the first sniff of an issue. What’s’ the difference? VC investors sit on a just a few boards and often spend years getting to know the details of their portfolio companies. This history allows them to put a misstep in context and patiently wait for the correction.  Well that and, generally, the investment is illiquid and can’t be sold anyway, which is fine because the VCs investors are locked in for 10 years. Contrast this with public investors who can concurrently be responsible for as many as 250 stocks and rarely have the luxury of taking a deep dive into the operations of the companies in their portfolios.  While VC report cards are made public rarely if ever, long-only fund managers see their grades in the papers or online every single day and can/have to make buy/sell/hold decisions every hour of every workday. When a newly public management team fails to deliver what was promised, the preferred course of action for a fund manager is to utter unkind things about the CEO and CFO, eject the stock from the portfolio and move along investments run by more credible teams.  As there really is no such thing as a one-quarter problem, this is almost always the right move.

And yet, sometimes, unexpected things do go bump in the night. When that happens, there are a few moves to make to perhaps cushion the inevitable fall.  The damage is done. The key is to regain credibility as quickly as possible.

 What follows are our suggestions.

1   Acknowledge right up front that the report does not match the forecast. Take full responsibility for the misstep.  Even if all the trains’ engines ran smoothly, failure to anticipate the log that rolled onto the track was a management blunder.

Management’s only smart move is to provide as much detail and transparency as possible (without exposing too much information to competitors, who will of course dialed in to the mea culpa conference call. The key is to demonstrate that the problem is well understood and the underlying issue identified. The CEO and CFO should expect an unpleasant conference call on which investors will ask very pointed questions. Management should be ready with detailed, data-driven answers.

2   Articulate a clear and credible plan to right the ship. Management should talk through the steps to recovery, the timing with which those steps can be implemented and a best guess as to how long it will take to see tangible evidence of the effectiveness of those changes. The following quarter’s earnings call is a very good time to tangible evidence of at least some progress.

     Demonstrate confidence in the plan.  Investors don’t actually expect companies to perform perfectly in perpetuity – there are zero examples of public companies that have never missed a forecast. Management’s job is to turn the bug into a feature, pull the team together and solve the problem. This is the time to show the mettle of management and to earn long-term fans in the investment community. It takes much more skill to sail a ship taking on water than to stay the course in a boat with the wind at its back. At this point, a smart management team will express confidence in the business, the team and the plan to get things back on track, no matter how long that might take.

     Execute on the plan in the time frame communicated.


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