With so many companies tenderizing the market with earnings warnings, how did they ever got along without them?
These are the times that try an IRO's soul. It seems that whenever a company issues an earnings warning, its stock gets utterly hammered by disappointed investors. The apparent recession means the bad news parade isn't likely to end soon. In the post-FD environment, can IR departments better handle the delicate task of managing expectations? If a pre-announcement is appropriate, can IROs feed the bad news to the market in such a way that the carnage is dampened?
Before attempting to answer those questions, let's hark back through the misty corridor of time to see how IROs of yore managed expectations. Before the SEC's Regulation FD, IR directors and senior managements could quietly 'guide' selected analysts by dropping more or less subtle hints. These analysts would then take the lead and regurgitate management's prognostications to investors. Any bad news would be slowly filtered down to the public and, if done skillfully, the stock price would gently ratchet down. When the poor numbers were finally revealed, the market had already largely discounted the news.
For better or worse, today's regulatory situation is completely different. If a company tries to use time-honored earnings estimate management techniques, it risks violating SEC rules. There are (legally) no more private chats with favored analysts, no more whisper numbers - from companies, that is. The ability to fulfill the IRO's prime directive of Thou shall not surprise has been compromised. Markets appear to have become more volatile as investors - large and small - react to negative announcements in concert. In the new environment, companies are still figuring out how to disclose information to all constituencies at the same time - and how much information is necessary.
But before a company begins the information dissemination process, it first has to know what investor expectations actually are. For larger companies, that is easily done - just look at the published estimates tallied by Thomson Financial/First Call. Smaller firms, with little or no analyst following, will have to dig deeper, inquiring directly with the audience that is buying their stock. That can be done through one-on-ones, by monitoring chat rooms and by conducting perception surveys.
Worst foot forward
If you determine that expectations are far enough off base that a pre-announcement is called for, you had better prepare for the worst. In this market, when you pre-announce, your stock will take a hit and there is a good chance it will take another when you release final numbers. One way or another, the short term is going to be messy. What you are trying to do is build credibility for the long term.
A good way to approach that task is to examine your company's prospects in terms of the very worst-case scenario. You may be inclined to include in your press release reassuring words or numbers garnered from an ever-optimistic marketing and sales force. Presenting mitigating factors is fine. But if you spell out a revised target and then miss it, your credibility will take a hit rivaling that taken by your stock price.
'Leave yourself room for things to be a lot worse than they presently appear,' counsels Ken Donenfeld, president of DGI Investor Relations. 'Whether you give a precise range of numbers or not, it is a lot better to consider the worse case and beat it going forward than to be seen as trying to smooth things over.'
'You want to avoid a second release saying things are even worse than you thought,' adds Andrew Komendantov, senior counselor at RTS Communications. 'It is very much in the company's best interest to really nail down your figures as closely as possible so that there are no further surprises.' It's further surprises that have recently got Swedish telecoms equipment maker Ericsson into hot water with investors. The company's management has destroyed credibility in its forecasts by repeatedly revising them downward.
'Ericsson management are not good at managing their business and that leads to poor guidance and consistent disappointment,' declares Simon Kirton, a fund manager at Aberdeen Asset Management. He adds that Ericsson's stock price has dropped because 'they have lost the overall confidence of investors.'
To avoid shareholders' wrath, it is also important to stay alert to what your competitors are saying. If all your peers are pre-announcing, and you stand firm until the very last moment, your management will appear to possess a less clear understanding of the environment than the others do. Effective IR strives to demonstrate that a sharp management is steering the ship in the right direction.
So, taking into account the aforementioned warning about 'serial warnings', try to time your announcement as soon as you have an iron-clad grip on what is going to come down the pike.
'Management's expectations must be shared with the Street as promptly as possible,' says Adam Friedman, head of IR consulting firm Adam Friedman Associates. 'Do not wait for what might be perceived as an auspicious moment because there are no more auspicious moments. While you will be punished for the surprise, the earlier you let the Street know, the more credibility you will earn. Trying to pre-announce on the eve of a holiday and hoping no-one notices is poor strategy. Everyone finds out anyway and it looks like a deliberate, sleazy subterfuge.'
It is the dream of IR officers to pre-announce bad news at a particular time of day that will mitigate volatility. But after-hours trading makes it hard to do that. Still, most warnings are issued outside normal trading hours to give analysts and investors a chance to digest the information.
Details, details
Once you decide you're going to pre-announce a shortfall relative to Street estimates, the next question is how much detail to include in your press release. Many companies have been accused of being more guarded in making interpretative comments to analysts than they were in the pre-FD era.
'Some managements simply say Street expectations are wrong and announce their numbers,' notes Friedman. 'The Street then wonders why things have deteriorated. The press release should give investors as much detail as management is comfortable with. That way, you can discuss any key issues with individual analysts and investors because you have already come out with the news.'
Even if an announcement provides reasons for the shortfall, the investor community is often presented with a sterile, lawyer-approved warning which doesn't provide sufficient context to assess its significance. It is one thing to say that analyst estimates are off by a certain range because order rates have unexpectedly deteriorated. It is another to spell out the circumstances in which management thinks orders will snap back.
Of course the challenge in making qualifying comments is to avoid exaggerations, either upward or downward. But companies using FD as an excuse for being vague risk having the Street misinterpret the importance of a warning. 'Lack of knowledge creates unease,' says William Galvin of Greenwich, Connecticut-based The Galvin Partnership.
While providing excuses and creating context is important, how specific should you be about future prospects? In fact, as part of your pre-announcement, should you be forecasting things like future quarter earnings, sales or growth levels? If you have a track record of doing so, a sudden halt may not be kind to your stock price. But many CEOs are simply throwing in the towel, admitting they can't forecast what's ahead. The term visibility (or lack thereof) has entered senior management's IR lexicon.
Veteran Toronto IR consultant Richard Wertheim challenges whether most companies had so-called visibility to begin with. 'The Street is surprised when a company says there is so much uncertainty that it cannot predict the next quarter or year,' notes Wertheim.
'But for most companies, that has always been the case. The time between order and delivery of many types of product is days or weeks. Once, you would have had to practically torture a company to get a forecast out of them. All of a sudden, many companies have developed a compulsion to forecast. It is a bit of a mystery why.'
'We counsel clients that they are better served by not making projections,' says IR consultant Andrew Edson. 'Once you start doing it, you can't just stop. You have to continue doing it. Not doing so is taking a more conservative approach but you run less risk [of being wrong].'
Why some companies are so keen to put pre-announcement numbers in investors' faces is curious. Sure, the feeling of intellectual closure is pleasant - for both companies and investors. But why not simply discuss general trends and temper expectations that way?
For example, if you are an airline, you might say, 'Fuel prices have gone up and for competitive reasons we will be unable to pass them on to customers. This will have a moderating effect on our profit margin. You can draw your own conclusions. As we get closer to the quarter's end we can begin to focus on actual numbers.'
Perhaps one reason for companies feeling they need to be so unsubtle is the quality of financial analysts who, like the media, were used to being spoon-fed numbers from companies. With the hot line between analysts and CFOs disconnected by Reg FD, analysts are now on their own and have to do a lot more legwork. Also, investors get a very different picture of the company from one source to the next. According to a veteran analyst, 'When I started my career, there were no spreadsheets. That meant you had to think every number through and actually get your fingers dirty touring plants. The imbeciles with spreadsheets don't, because that is not what they were taught at business school.'
It's easy enough to blame analysts for trouble they failed to see coming. But for their part, analysts complain that the quantity and quality of information they get from companies has fallen since the advent of Regulation FD.
A survey conducted by the Association for Investment Management and Research (AIMR) indicates that 81 percent of its members feel some companies are using the new rules as an excuse to minimize communications with investors. Some 71 percent believe the reduced information flow is contributing to current market volatility.
'People have had an unrealistic expectation of what is available in the market,' says Marvin Pickholz, an attorney and former assistant director of enforcement at the SEC. 'Expectations should be tempered. The stock market is no longer the exclusive domain of the affluent and sophisticated. Even the US government is telling people they ought to put their money in the stock market for their retirement. With so many Americans investing in stocks, Wall Street owes them an honest, level playing field.'
Pre-announcement obligations under FD may still be a gray area, but many IR consultants suggest that best practice remains a matter of keeping communication lines open. 'If management is aware that it will not meet published analyst earnings targets, they have an obligation to let the analyst and investor community know,' says Bob Jones, head of the IR practice at Morgen-Walke. 'The best way of doing that is with a widely disseminated press release followed by a conference call.'
After the fall
How you deal with the aftermath of an earnings warning can be as critical as how you present the news itself. If damage will be done, then the issue is damage control. A conference call may be in order at the time of the announcement. Then follow up with proactive one-on-one phone calls to key analysts and investors. Your investors have just taken a hit and they appreciate someone who takes the time to make a call and answer non-material questions. You may only be able to offer cold comfort, but that's better than no comfort at all.
You are likely to get plenty of questions following your pre-announcement. Be prepared: swiftly update your web site and get your Q&A together. Some companies draft a customized e-mail to retail shareholders. In some instances, be ready to enlist the help of other departments within your organization to handle the volume of calls. 'As long as it is civil, no phone call goes unanswered at Unisys,' James Kerr, IR director, told IROs at a recent Investor Relations magazine conference. 'With companies experiencing rumors about bankruptcy and cash levels that are easily spread, a ringing phone means you are out of business.'
At the end of the day, companies could avoid pre-announcing altogether if they learned to better manage Wall Street expectations. Easier said than done, perhaps, but not impossible. Many strategies exist. For example, Craig Johnson, principal vendor and product analyst at Portland, Oregon-based Pita Group, believes success is most likely for companies that closely integrate the IR and marketing functions. 'Financial analysts are used to repeating what people tell them,' says Johnson. 'If you do a full court press with the same message across multiple fronts - industry analysts, financial analysts, the public and the press - then you should be able to manage the Street better.'
Of course, the expectations management process begins back at your company with forecasts from the bean counters. But since many firms, particularly high techs, have never experienced a significant downturn, it may take more than a few quarters for exuberant managements to come to grips with reality. They are learning that, regrettably, perception is not reality.