To paraphrase Einstein, things should be as simple as possible, but not too simple. From that starting point, good investing at Cove Street Capital begins with analysis of business model, security valuation, and an assessment of the people running the show. This piece begins a running dialogue on the latter issue, and our primary source for the next three months will be the Proxy statement as filed with the SEC that details executive compensation.
It has become common practice in institutional investment management to outsource the practice of establishing what constitutes effective incentives for those responsible for running the companies in which we are investing to the third party services like Glass Lewis and ISS. Naturally, that dissolves into a disastrous Kabuki dance with companies hiring these firms and other consultants to design compensation plans and corporate governance structures that will pass muster with these same entities, utilizing the politically correct fads of the day. (Hold your vote for Warren Buffett—awful governance at Berkshire.) And if you are charging fees on 2 trillion dollars in essentially passive vehicles, you simply don’t give a damn—you just don’t want people picketing your headquarters or having to listen to Elizabeth Warren invoking your name on the Senate Floor.
We take a slightly different approach. While each lead analyst for an idea is naturally reading all available information on a holding, each analyst takes a rotating turn as the “proxy guy” for our firm for the year. While the thought of hiring a new analyst this year to take my “turn” so I can focus on “more important things” did cross my mind, now that I have gone through three companies I am re-hooked. It is a really, really good exercise to understanding people and culture, and anything that cannot be spread-sheeted to death is worth thinking about…because there seems to be a lot less grey matter devoted to this area in our business. And seriously, are you actually watching the whole game?
So, it begins. TE Connectivity is on today’s plate. Simply, it is a spin-off from the original Tyco conglomerate, which gobbled up AMP, a former holding. We own it in our All Cap strategy—good company, good returns, good free cashflow, generally good long-term outlook. As part of the TYCO corporate governance disaster, the reconstituted Board threw every consultant known to man at the problem and created the modern blueprint for what constitutes highly transparent, highly consulted, down the middle of the road on every issue executive comp and corporate governance in 122 pages before the appendix.
Things have changed for the worse. The entire plan has been changed to reward growth, Earnings Per Share measures, and encouraging acquisitions, which management has been only too happy to oblige with increasingly high prices being paid to reestablish “strategic vision.” Any balance between growth and “returns” on our money being spent has disappeared. And then there is this paragraph, which is simply AWFUL and like a bad movie I have seen before, I know I will see it persistently over the next three months.
For purposes of the annual incentive program, all of the financial metrics are adjusted financial measures (i.e., they do not conform to U.S. Generally Accepted Accounting Principles) that exclude the effects of events deemed not to reflect the actual performance of our employees. For fiscal year 2016, the adjustments to EPS, revenue and operating income, as applicable, were as follows (i) exclusion of acquisition related charges, (ii) exclusion of restructuring and other charges, (iii) exclusion of the impact of certain acquisitions, (iv) exclusion of the impact of changes resulting from the foreign currency exchange rates (with respect to performance measures at the business unit level), (v) exclusion of certain corporate allocations (with respect to performance measures at the business unit level), and (vi) exclusion of income tax benefits associated with the settlement of audits of prior year income tax returns as well as the related impact to other expense pursuant to the tax sharing agreement with Tyco International plc and Covidien plc and exclusion of income tax charges related to an increase in the valuation allowance for certain U.S. deferred tax assets.
In a world of “Alternative Truth,” what cannot possibly be “adjusted” to make numbers for a payoff? If you exclude acquisition costs, then what acquisition cannot be justified? If you don’t count restructuring costs, then what are the ramifications for a giant and expensive mistake?
I will hold full editorializing for June when the “season” is over.
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