Capital Markets

How to Wreck Your Company’s Valuation

Avoid reconciling GAAP and non-GAAP reporting, providing metrics used in business modeling, or breaking out the results of acquired companies, and ...
David McCannNovember 17, 2009

If your company has not stopped or reduced earnings guidance during the recession, as quite a few have done, you may at least have thought about it. And chances are that if you opted not to withdraw guidance, one reason was concern that the company would look like it was hiding something, with a resulting hit to its stock price.

Indeed, few stock analysts would counsel companies to keep mum on their earnings outlook, especially since guidance is typically a key factor in their ratings. But one dissenter, speaking at Financial Executives International’s annual Current Financial Reporting Issues conference in New York City on Monday, said a fuller picture of a company’s business could actually emerge in the absence of guidance.

The environment for stocks has been volatile, to be sure. It’s tough to say whether less discussion about future earnings has played any part in that. But withdrawn guidance gives analysts and investors “an opportunity to take intellectual rigor and dig into the fundamentals maybe more than they had in the last 10 years,” according to Heather Bellini, managing director of ISI Group Inc.

The key is that, in place of saying what the bottom line will look like, companies should take the veil off the metrics on the underlying drivers of the business that they use in their business modeling, Bellini said. She singled out Microsoft for praise, saying it has “gotten better each quarter” at doing that since ending guidance at the beginning of 2009. “It’s been a learning process for analysts that we should have paid attention to this key factor that we were missing before,” she said. “For those [analysts] who complain about it, it’s really an opportunity to have their numbers be different from the Street and have a reason for them to be that way.”

But when it comes to reporting past earnings performance, Bellini wants more information, period. Most companies routinely report two sets of results, one based on generally accepted accounting principles and the other a non-GAAP treatment that omits, for example, nonrecurring charges such as amortization on recently acquired assets and stock-option expense. But Bellini said most companies do a poor job of reconciling the GAAP and non-GAAP numbers, if they bother with reconciliation at all.

That can hurt a company’s valuation, according to the analyst. “It’s no different than buying a car,” she said: the harder you make it for people to invest in the company, the fewer will do so. Plus, she noted, if your competitors are giving out reconciled numbers and you aren’t, you’re at a disadvantage. “If we can’t figure out what the non-GAAP numbers are on a reliable basis, you’re going to be valued at a discount to the company that gives [reliable] non-GAAP measures.”

Bellini was also critical of companies that refuse to break out the revenue contributions of recently acquired companies. “No one believes you when you say, one quarter after the deal closes, that you [don’t know] what revenue came from the acquisition,” she said. Companies should provide broken-out numbers for at least four quarters postdeal and in some cases much longer, according to Bellini.

In the case of Oracle’s 2005 purchase of PeopleSoft, she noted, the companies were very clear that the value of the deal would play out over five years — yet Oracle stopped giving out information on the revenue PeopleSoft was contributing after just one year. “That’s something every company can get better on,” she said.

Management teams often are afraid to provide the breakouts “because if the deal goes south, they want to cover it up,” said Bellini. But that is a fruitless effort, she insisted. If the acquisition doesn’t go well, everyone will know because the company will not perform as well overall as had been expected. Indeed, such a cover-up is counterproductive: “Companies that are more forthcoming actually end up getting a higher multiple assigned to them, because people value that level of integrity,” she said.

But while analysts prefer to have as much information as possible, they don’t want to get it during earnings calls. Bellini griped that calls can drag on for an hour and a half, including a half-hour spent listening to the CFO read the press release, line item by line item.

“Every quarter they go through the same rigmarole, telling you every metric, what it was as a percentage of sales, what the year-over-year growth is,” she said. “Let’s get to the heart of the matter.” To Bellini that means talking about what went differently from what people had expected, what the key performance indicators are going forward, and what your macro drivers are and their impact on those KPIs.

“I think everyone would get a lot more value out of that than the way a lot of calls are structured today, which frankly seems to be filler,” the analyst concluded.


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