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Show us your CEO stuff
So you think you could do better than some of the CEOs running big companies? Give us a turnaround strategy for stumbling blue chips Schwab, Merck or Delta.
By Jim Jubak
How many times, upon learning about another business disaster, have you thought "I could do a better job than that bozo they have running the company?"
Looking at the disaster still unfolding at Merck (MRK, news, msgs), the floundering at The Charles Schwab Corp. (SCH, news, msgs), the very expensive fines paid and paid again to settle charges of accounting fraud at what was called America Online (and is now the AOL unit of Time Warner (TWX, news, msgs)), and the flameout of full-cost airlines from UAL (UALAQ, news, msgs) to Delta Air Lines (DAL, news, msgs), it's hard to imagine that anyone plucked randomly off the street couldn't have done a better job. Current or former CEOs at those companies have cost investors billions.
And, of course, who wouldn't like a shot at the dough that even a bad CEO can earn. Or the chance to get paid even more for out-and-out failure. For example, David Pottruck received a salary of $1 million for 2003 while he was CEO of Schwab, plus a bonus of $4.7 million in cash and a grant of 365,000 shares of restricted stock, worth $4.3 million on Dec. 31, 2003. (Pottruck declined the cash bonus so that the money would be available to pay bonuses to other employees.)
Pottruck stepped down as CEO in July after the companys board of directors asked for his resignation. But the ex-CEO has now signed a new 30-month contract (for unspecified duties) that calls for a $6.2 million lump-sum payment and a pay raise to $1.6 million annually. In addition he gets to keep those 365,000 shares, even though they weren't supposed to vest until 2008, and a 2003 award of 1.4 million options at an exercise price of $8.88 a share.
Not bad work if you can get it.
I'm going to give you a chance to prove that you can do the job and deserve the compensation just as much as some of these jokers -- on paper, at least. In this column I'll outline the problems at three very troubled companies, Charles Schwab, Merck and Delta Air Lines. Then I'll ask you, my readers, to come up with a fix for the company's problems.
Now, the fix can't depend on external events. No fair "fixing" Delta's problems by assuming oil drops to $12 a barrel, or Merck's by imagining the company's labs discover a cure for cancer.
Pick one of the three companies and send me the strategy that you'd apply as CEO by e-mail by Monday, Dec. 20. I'll publish the best in my first post-Christmas column on Dec. 28. The top three readers' suggestions, in the opinion of our one-person panel of judges, will get their choice of a copy of either "The Stock Trader's Almanac for 2005," "The Coming Generational Storm" (Laurence Kotlikoff and Scott Burns' very scary book about war between the generations over retirement), or Aswath Damodaran's new book "Investment Fables."
Besides the excitement of competing for such valuable prizes, this exercise does offer an investment lesson. Value investors looking for cheap stocks that might soar after a turnaround need to ask themselves how difficult a turnaround at the company would be. Your CEO strategies for these three deeply depressed stocks will give you an idea of how long it would take to right these three companies and help decide if any of them are potential value buys.
Now here are the three problems that need your solutions. Aspiring CEOs, start your engines.
Charles Schwab
Pottruck took the fall for the failure of the company's strategy to go upscale. (Bear in mind that company founder Charles Schwab was co-CEO with Pottruck until May 2003. But when you still own 20% of the company's stock, as Schwab does, the board of directors gives you the job of saving the company rather than tossing you out in the cold. In your strategy, you should assume that you've been hired to take over the CEO job from Schwab.)
Related commentary on MSN Money
Schwab's record is uneven at best when it comes to investing in new business opportunities. In an attempt to move into the investment banking business, the company purchased Soundview Technology Group for $289 million in late 2003. A year later Schwab announced it was selling the unit for an $87 million loss. The jury is still out on its purchase of the U.S. Trust private banking business in 2000. So far, however, that deal hasn't provided Schwab with the hoped-for flow of fees and assets, and pretax operating margin has dropped to 6.5% so far in 2004 from 12% in 2003. The failure of those moves has left Schwab without a strategy. So, for example, on Nov. 12, the company announced that it intends to merge existing offices and cut staff yet again. With about 90% of all trades executed online, the company's expensive brick-and-mortar office network is a cost that the company just can't afford. After the changes, the company will have 282 offices, down from 400 three years ago.
But at just about the same time, the company announced that it would open 54 new satellite offices that would help clients manage their accounts and assets. "Our clients have made clear to us that they want the opportunity to be able to develop a relationship and connect more with an individual," Walt Bettinger, the head of the company's branch network, told the Los Angles Times. Now that sounds like a full-service brokerage strategy, doesn't it? But on the other hand, the company has belatedly reacted to its more aggressive online competitors by cutting trading commissions. Sounds like a discount brokerage strategy, no?
About 70% of Schwab's revenue comes from sources other than trading, including the fees it earns from the 5,000 independent financial advisors who manage $300 billion in assets through Schwab. But the company's 7.5 million active client accounts provide the customers for that non-trading income from asset management, mortgage, life insurance and other products.
Merck
Vioxx, the arthritis pain killer withdrawn from the market on Sept. 30, is certainly Merck's most expensive problem. Merck's legal liability is estimated at upwards of $15 billion. But Vioxx isn't the toughest challenge facing any successor to current CEO Raymond Gillmartin. The company must replace Vioxx's $1.5 billion in annual sales while at the same time stemming the 15% decline in 2005 sales of Zocor, its blockbuster cholesterol drug. In 2006 Zocor loses its patent protection and generic drugs are sure to cut into its annual sales of $3 billion. One of the best prospects for filling the gap, Arcoxia, another arthritis drug, now looks unlikely to get speedy approval from the U.S. Food and Drug Administration in light of Vioxx's problems.
Current CEO Gillmartin has been pushing hard to get drugs from lab to market faster since he took control in 1994, which may be part of the reason the company finds itself in the current Vioxx mess. That effort, however, hasn't refilled the pipeline. The good news for any prospective CEO is that just about anything is on the table. In November the board of directors awarded top executives so-called golden parachutes -- big pay packages that are triggered in the event the company is sold or merged. While that raised the hackles of investors, the golden parachutes also make it clear that the board is willing to think about a big deal that would radically restructure the company. A new CEO has another advantage: the kind that a big cash balance brings. The company is sitting on about $13 billion in cash and generates more than enough cash flow from operations to cover the current 5% dividend. Merck has devoted a hunk of the cash in the bank to buying back shares, which along with the dividend helps support the stock price. But the company could use that cash for acquisitions at a time when its stock doesn't make a very attractive currency. (Prospective CEOs: please don't suggest that Merck buy a drug-benefits management company. Been there. Done that.)
Delta Air Lines
It's certainly unfair to blame current CEO Gerald Grinstein for Delta's most recent crisis, since he's only been running the ship since January. Almost all of his efforts have focused on cutting costs so that the company can avoid bankruptcy. On that front, he's had some success: Delta's pilots approved a deal that saves more than $5 billion over five years through a combination of a 33% wage cut, changes in work rules that should boost productivity and reductions in the pension plan. All those concessions helped secure $1 billion in capital. And more cuts are ahead, with 6,000 non-pilot jobs set to be cut.
But all this addresses only one-half of Delta's problem: the cost side. These steps don't begin to address the need for more revenue -- operating revenue is down about 20% since 2001 --and some profit. Airline seats have become a commodity with commodity pricing. That's a problem when an abundance of capital to buy new planes keeps increasing the supply of the commodity. That means that the price of a ticket to Los Angeles next year will be less than it is this year. So cutting costs doesn't really solve the problem at Delta. It merely postpones it.
And unlike the situation at Merck, you as CEO of Delta don't have a lot of time. The company finished 2003 with $18 billion in debt, if you include aircraft leases. Current cash flow isn't enough to pay interest on that debt and also meet the company's pension obligations, so the company has been drawing down its cash -- hence the need to raise outside capital. As new CEO, assume that the current cost-cutting delivers the savings promised without totally alienating the work force. Your challenge is to find a way out of the commodity price box.
Okay, you've got the weekend to come up with a solution for the company of your choices. (Hey, I'm not looking for a business plan -- just a paragraph or two.) Let's see what you can do as CEO.
New developments on past columns
5 stocks that could soar if rates stay low
On Dec. 14 Engineered Support Systems (EASI, news, msgs) reported record revenue and net earnings for the quarter ended on Oct. 31, 2004, and then raised its guidance for the 2005 fiscal year that ends in October 2005 to $3.10 to $3.15 a share, well above the Wall Street consensus projection of $3 a share. Because the company is in the business of logistical support for the U.S. military, it can count on seeing its order backlog grow as long as the U.S. military budget keeps growing. And that trend seems firmly in place for 2005 if the recent funding request from the Pentagon for operations in Iraq is any indication. The request for $80 to $85 billion surprised lawmakers and even some members of the Bush administration, who had been expecting a request for $70 to $75 billion. The funded contract backlog at Engineered Support Systems rose to $588 million, another record for the company and equal to two quarters of revenue for the company. Not a bad insurance policy to be carrying as the company heads into 2005. As of Dec. 17, I'm keeping my target price at $68 a share but stretching out the schedule to May 2005. (Full disclosure: I own shares of Engineered Support Systems.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Engineered Support Systems. He does not own short positions in any stock mentioned in this column.
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