Thursday, January 29, 2009

Good CEO/Bad CEO Investing

By Eric Jackson

1/28/2009 11:45 AM EST

The bestselling author of Why Smart Executives Fail, Sydney Finkelstein is Steven Roth Professor of Management at the Tuck School at Dartmouth College. His upcoming book,Think Again: Why Good Leaders Make Decisions, coauthored by Jo Whitehead and Andrew Campbell and published by Harvard Business Press, expands on why companies run by sharp executives run off the rails.

After discussing the main themes of his new book and how they relate to the current market environment, we moved on to translating his research on executive and board decision-making into tangible investment ideas.

Jackson: What are examples of corporate leaders who make smart decisions and whose companies would make good long bets?

Finkelstein: I'll start with Jeff Bezos of Amazon (AMZN - commentary - Cramer's Take). That's a company that keeps on going even though no one gave it much of a chance in 2001. Remember that he had the foresight -- or good luck -- to tap the debt markets for $1 billion. This helped Amazon weather the storm after the Internet bubble burst. He's made his strategy work and he's innovative in ways that are complementary to the core business.

This is anecdotal, but I've had so many people ask me if my new book is coming out on Kindle. (Editor's Note: It is.) They've told me they wouldn't read it unless it did. Bezos has had a strong vision for what he wanted the company to be and stuck with it. He experimented with offshoots to the core business without getting too far afield. He also surrounded himself with good team members who appear to have been unafraid to challenge him.

Jackson: People worry about Amazon's high valuation.

Finkelstein: I'm not a valuation expert, I'm a leadership expert. However, I do know that good leaders do the necessary things to keep growing their businesses in sustainable ways. For that reason, I think Amazon is a good pick.

Another great corporate leader is Sandy Cutler at Eaton (ETN - commentary - Cramer's Take)(ETN). He's a Tuck grad, so I've had the chance to meet him several times at the school and he's always impressed me.

I haven't met anyone more knowledgeable about M&A. He knows how to integrate a company, how not to overpay. He's built a very strong organization around him. He always demands a good debate from the executive team. He also wouldn't be comfortable with me singling him out alone; he would always credit the team. Eaton's stock is down by half in the last year, but it's ahead of many peers in the market.

Google (GOOG - commentary - Cramer's Take) has also done a good job. It has one business that makes money and 29 that don't. A bunch of these that don't make sense have been jettisoned. Google is growing up. It was fine to experiment when times were flush, and you want to keep talented people around. Now it's being serious and cutting and not hiring.

New CFO Patrick Pichette seems to have done a good job here. No one could believe how well Google put the brakes on costs in the last earnings call. Capital spending dropped by half of what was spent a year ago and only 99 people were hired last quarter, down from thousands in past quarters. The company appears to have an excellent management team: It's not just Eric Schmidt, Sergey Brin and Larry Page. Shona Brown is also very strong.

Lastly, I'll mention General Electric (GE - commentary - Cramer's Take) and Jeff Immelt, even though the stock has been savaged. He was dealt the toughest hand you could possibly be dealt for an incoming CEO: following the most famous CEO ever, as well as dealing with Sept. 11 and the general stock market decline that followed. He's focused on some important themes: globalizing, going green and continuing to develop talent. He's controlled what he can control.

Jackson: Let's shift to examples of CEOs doing the opposite of what you advise and which companies, as a result, would make good short candidates.

Finkelstein: I'll start with Ken Lewis at Bank of America (BAC - commentary - Cramer's Take). It's amazing to me that he still has a job. Lewis cut his teeth as a credit analyst under Hugh McColl at North Carolina National Bank, later overseeing the bank's aggressive acquisition strategy. He got the top job in 2001 -- most people thought Lewis would be less acquisitive than McColl, but it has been just the opposite.

This is going to sound a little like armchair psychology,but for Lewis to be a major success at BofA, he knew he'd have to surpass McColl, already a legend in Charlotte for growing the bank into such a global powerhouse. How do you do that? You've got to make acquisitions and grow this bank even bigger. In 2003, he bough FleetBoston Bank for $48 billion. He bought MBNA in 2005 for $34 billion. And in April 2007, he bought LaSalle Bank for $21 billion.

He followed the Citigroup (C - commentary - Cramer's Take) failed "financial supermarket" strategy. Then BofA took on Countrywide for $4 billion and Merrill for $50 billion this year, with all the ticking time bombs in their portfolios. You're looking at another Citi. Lewis has been overly attached to his image of needing to be better than McColl.

There's another aspect to Lewis that relates to what we discuss in the book: He based his decision-making in 2008on misleading past experiences. BofA was built on many small bank acquisitions. McColl would cut costs and look for revenue enhancements, which gives you greater market power and heft. It's a great model, on such a different scale than Fleet, MBNA, Countrywide and Merrill.

Lewis thought -- based on Fleet and MBNA -- that he knew how to do these big acquisitions. He didn't. The due diligence was shockingly short on Merrill. This was a trophy acquisition. Reports are that Lewis wanted this jewel for a while. If the stock goes up, I would look to short it. I would bet there are more skeletons in their book.

Staying with financials, when you think of what Citi was and what it could have been, it's a tragedy. Citi has been incredibly slow to face up to problems. It took far too long to replace former Chair Sir Win Bischoff. There were rumors that he was on his way out for months. Dick Parsons appeared to be the de facto chair anyways, so what was holding Citi up?
It's also obvious that Citi moved too slow to break up the company. It's only been done begrudgingly and probably at the insistence of the new owners -- the U.S. government.

Vikram Pandit is a disastrous CEO. It's a tossup if he's worse than Charles Prince. You really wonder where was the board in all this? Why are most of the directors still there after making two terrible picks? When you think of the job of a board of directors, its most important job is hiring the CEO. Citi's board has failed twice now in this most basic function.

How they picked Pandit is a story in itself. He ran a hedge fund that seemed to be successful, but a year later Old Lane proved to have made many terrible bets. The performance plummeted, redemptions were through the roof and Citi needed to inject it with capital to keep it going. It has since been shut down.

Pandit was picked because basically any other senior talent in the company had been driven away months and years earlier. Pandit's been in way over his head from the start.
The lesson from Citi is: you've got to face reality immediately and move on. And for the board, the lesson is: you can't be attached to the CEO you pick. Your attachment can blind you to what's going on. Until there are major CEO and board changes, Citi is a short.

Finally, Jerry Yang at Yahoo! (YHOO - commentary - Cramer's Take) clearly made a number of poor decisions as CEO. First of all, he had an inappropriate attachment to Yahoo! from the beginning as a cofounder. From the outside, it also appears that he (and others on the management team) were very much against the idea of selling to the "evil empire" of Microsoft. As a result, he left $30 billion on the table for his shareholders.

Even now with Carol Bartz, about whom I've heard a lot of very positive things, I wonder whether Yang would approve a deal if it came along.

The other major problem with Yahoo! -- even more important, in fact -- is the tired board. It didn't pay any attention to Terry Semel, except when it came to approving his monster pay packages; let Yang be CEO when he wanted to instead of doing a thorough search; and let the company go through countless reorganizations with no results and no accountability.

How can you expect the rest of the organization to be accountable when no one on this board has been accountable? Even if Bartz is exactly the right CEO, she's going to be saddled with one of the worst boards in corporate America. What shocks me the most is that Yahoo!'s largest shareholders sit back and except this. They are gluttons for punishment.

Sphere: Related Content
blog comments powered by Disqus