Wall Street has a lot of traditions and rituals. Some, like making major corporate announcements outside of trading hours, make sense and have been the standard for decades. Others, like the human-tossing depicted in the based-on-fact movie,The Wolf of Wall Street, didn’t catch on — thankfully.
One latter-day tradition for publicly traded companies is “forward guidance.” That’s when, during a quarterly earnings announcement and/or conference call, management offers its own best estimate on its next quarter’s or next year’s revenue and earnings.
This tradition began in the 1990s and became much more common after the dot-com bubble burst in 2000 and 2001, and managements were required to disclose any company information more widely and without favor.
In fact, forward guidance is pretty much the norm now, so much so that it’s become fashionable among some higher-profile private companies that after its IPO, it won’t offer guidance. Google (GOOG) most famously took this stance in 2004.
But the truth is that many public companies hate giving forward guidance. CEOs feel it’s just a game.
The Price is Right
This is a game in which companies issue guidance but pretend to be unaware of the jockeying of Wall Street analysts trying to be just below but not over the financial results the company will ultimately produce.
This bizarre variant of “The Price is Right” annoys CEOs who wonder why they have to be part of a childish game that seems to exist only for the benefit of sell-side analysts, but which provides nothing tangible for the executives or their company.
And those CEOs and CFOs are right about that game. But forward guidance does have a large, material value for a completely different reason. And conveniently, there’s a recent, vivid example of the dollar value of forward guidance, and the cost to a company and its shareholders if management refuses to offer it.
Back on July 29, Cimpress N.V. (CMPR), which until a few months ago was known by the more familiar name Vistaprint, released its June quarter earnings. During the accompanying conference call, CEO Robert Keane said the following:
“We do recognize that forward-looking guidance is common in a lot of companies, but we feel that the amount of time and energy that we need to put into that to make sure that it is accurate and to update it and then to explain the variances from it actually doesn’t, frankly and no offense intended, help us make a more valuable intrinsic value per share.”
The next day, Cimpress stock fell more than 18%. Considering that the company had just beat Street EPS expectations by $0.27 and (no small irony) its own guidance from the prior quarter, the air-pocket stock decline can be pretty much attributed entirely to the change in forward-guidance policy.
Let’s see, Cimpress has about 32 million shares outstanding, and the stock dropped by fifteen bucks. That’s $480 million in lost shareholder value.
Why did the Street punish Cimpress for changing its guidance policy? No, it’s not because of that silly “Price is Right” game I mentioned earlier.
Rather, it’s because investors use guidance to gauge a company’s confidence in its own business model. When companies like Google and Cimpress says they aren’t going to “give guidance,” that doesn’t mean guidance doesn’t exist. It does.
Every company large enough to be publicly traded performs internal planning. For expected revenues. For expenses, both variable and fixed. For headcount. And tax rates. And ultimately, earnings.
Internally, every senior manager and executive knows these expectations — often their compensation is tied directly to how well the company performs versus that internal guidance.
So “giving guidance” isn’t hard at all. Basically no further work is required of the CEO and CFO … they just have to be willing to state it publicly.
Mr. Keane is no longer willing, and the reaction speaks for itself. Meanwhile, many employees Cimpress had paid with stock or options are poorer and underwater, respectively. But the sheer drop in share value isn’t the only cost.
Cimpress is an acquisitive company. While most of its recent acquisitions have been paid for in cash, some, like its recent Druck.at purchase included a deferred payment payable, at Cimpress’s option, in cash or stock.
A cheaper stock means it would have to issue more shares. And a few years back, in the December 2011 acquisition of Webs, Cimpress (then Vistaprint) granted restricted stock options to that company’s founding shareholders.
These RSAs likely had a fixed strike price. Which makes the absolute level of the stock very important.
Even if Cimpress pays for an acquisition in cash, it may be doing so via a credit facility (true for its Pixartprinting acquisition in 2014), the interest rate for which is tied to the company’s market value.
Like any substantial company with a history of acquisitions, Cimpress probably has a short list of future acquisition candidates. But all those candidates just got more expensive.
And growth via accretive acquisition will be slower and stock appreciation will be slower because finding deals where the internal rate of return is greater than the cost of capital will by definition be harder.
CEOs who disdain or avoid guidance often complain that they simply don’t want to play the earnings game I described earlier.
They and their venture capital backers often say the guidance game promotes short-term thinking and hinders the ability to make long-term investments (i.e., lose money in the short run for a longer term strategic payoff).
But this is a fallacy, and there’s plenty of proof. Take Intuit (INTU), for example. The tax-and-accounting-software juggernaut typically loses money in three out of four quarters but makes it all back and more in its all-important April quarter. Intuit’s management also gives forward guidance.
It makes clear its plans and is willing to be judged by how well it meets them. Look at Intuit’s 20-year share price trajectory. (I’ll wait here, but take it from me: it’s “up and to the right.”)
In short, the only short-term thinking is being done by CEOs and CFOs who fail to understand the value of guidance to investors.
Guidance is nothing more than a marker of a company’s willingness to be judged by the business plan to which it’s already committed. And since that planning a sunk cost, you might say, the price is right.
Disclosure: Randall owns CMPR.
Any investments discussed in this presentation are for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments are presented for discussion purposes only and are not a reliable indicator of the performance or investment profile of any composite or client account. Further, the reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.