Aug

20

Picture book ad for HPBack in about 1994, my wife and I started investing in individual stocks. We did not have much to invest but if we had a couple hundred from say a race won or a tax refund we would research what to buy. We would go to the local library and look up the latest issue of Value Line, to come up with our top ten prospects. Then we would look at their recent statements compared to its competitors to screen out the candidates. HWP was one of our initial purchases,(before the COMPAQ merger ticker switch to HPQ).

While we made several mistakes on other stocks, HWP initially was a great buy., as were most any tech stock back then. Still HWP bet the QQQ.and IBM for first few years. While we had a good initial screening plan, we made several beginners mistake. We had no exit strategy, except to rely on our broker. Further, once we had about 10 stocks we simply started adding to the over performers buying highs.

Then in July of 1999 thing quickly changed with the announcement of Platt's retirement and Carly Fiorina as the replacing CEO. The market voted their disappointment with their feet. Quickly the over performance turn to underperformance compared to QQQ. Meanwhile IBM had started addressing it problems and was out performing by about 96. And of course in hindsight I would have been much better to sale and switch to IBM in 1996.

But HWP was my second best stock, so I kept buying. Then of course the QQQ dropped in 2000 and 2001. But in 2001, to add injury to insult Fiorina got into a proxy fight with the founders son, a board member over the Compaq merger. I kept voting against the merger, but kept getting packets asking me to change my vote. Once they got enough votes by the big mutual funds they finally merged. This of course did not improve things. Finally, I got the message and sold in 2001.

Carly was out by 2005, by shareholder accounts a failure, compared to the QQQ their peers and by price the stock had lost half its value.

Hurd brought HPQ back to over performing. But with his ouster, the stock still has made up for Carly underperformance, but has given up the long term over performanc (to QQQ) of his and Carlly combined tenure.

The moral of the story, is perhaps Platt, Carly, and Hurd or any other CEO is not worth, the billions that is lost by the market. But the Board is telling the market something. Are these isolated events? These stumbles would seem to be predictive of future mistakes or perhaps predictive of simply poor oversight and contempt for the shareholders?

Further, while mergers, may not subtract value, such as Intel, in and of themselves, but do they signal poor future decisions and similar contempt for the shareholders?

Has there been a study to see if these CEO drops are actually predictive of the incumbent CEO tenure? And has there been a study to see if these bad merger announcements, ones that the sums of the parts are clearly negative, signal future underperformance.

Victor Niederhoffer says:

Russ's post about his "layman's" experiences with HPQ should be on television. It's a perfect and useful story for our times. Everything the fast runner does is pitch perfect in my opinion.

Rocky Humbert replies:

There is abundant academic research which shows that most mergers don't create value, particularly in technology. However, the results are skewed by a handful of large deals — and don't give consideration to whether a company is buying a technology which can be exploited — or whether it's some sort of obtuse synergistic strategy proposed by investment bankers and ratified by megalomaniac CEO's. It doesn't take a genius to realize that if a buyer pays a 30% to 50% premium to the market for an acquisition, it's a difficult hurdle to overcome [unless the target was too cheap before the bid.] Importantly, these studies can't answer the question "what if"– since there are an infinite number of alternate scenarios which might have been even worse than overpaying for another company– especially depending on the timeframe. There's also a Wall Street meme at work here. Back in the days of Cendant, every deal "created" value– even though it was just smoke-and-mirrors.

You ask whether an academic has studied "whether the market's initial reaction is predictive of the long term success of a merger," and I'm sure there are papers on this– and I'm also sure that the papers are useless for investors since the forest gets confused with the trees. Case in point: The market "loved" the AOL/Time-Warner deal. Enough said.

There are a lot of papers about CEO departures. Here's one. It's EXTREMELY rare for a CEO to depart after good stock performance (except for retirement, health, etc.) I generally don't pay attention to CEO's unless I consider them to be lazy, unethical, inconsistent or undeserving of their job.

Lastly, I should disclose that since 1997, I did not invest (as distinct from speculate) in technology stocks. Putting the business/innovation/franchise aspects aside, it's only in the past year that certain technology stocks have finally reached valuations which can generate double-digit returns for investors with a static p/e assumption and 3-5 year time horizon…

James Goldcamp comments:

I took Rocky's post to imply something I also believe to be true. Much of a CEO's (perceived) performance is the result of random factors and timing and in many ways are like the ephemeral economic reports, to which chair often refers, that get revised (just like Neutron Jack, Chainsaw Al, and the ousted CEO's predecessor get revised down years later after being previously uniformly lauded). Also, CEO stories probably cause to much focus on the narrative, rather than the underlying business fundamentals, causing mis-pricing of securities when there is excessive negative or positive headlines regarding the executive (to which Rocky has alluded with a prior post about the departure of HP's CEO and questions of how many B's the CEO is really worth).

I didn't take from Rocky's post that CEO's are overpaid, though I will go as far to say that in my opinion directors of public companies have not (in general) been sufficiently diligent with compensation and insuring an appropriate alignment of interests between shareholder and management, especially with respect to cases where said executives do not have "skin in the game".

Disclosure: I was a buyer of shares in HPQ and INTC this week. (among other things)
 


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