Wednesday, September 25, 2013

Rewarding failure: blame it on the ex-wife

While Americans are used to paying large bonuses for failure, it’s not as common in Europe. Apparently Helsinki newspapers are alight with the controversy over the $25 million bonus Nokia plans to pay CEO Stephen Elop for halving the company’s market cap.

Elop’s failure has been long in coming. When Nokia announced its Windows strategy in February 2011, I (admittedly) mixed my metaphors:

Nokia CEO (and Microsoft veteran) Stephen Elop had already prepared the troops with his “burning platforms” memo, lambasting his new employer for how it failed to respond to the iPhone and Android challenge.

Elop has jumped off the burning oil platform into a ship that’s adrift and has a hold filled with water.

The sign of a troubled company is multiple Hail Mary passes in a row. … Nokia needs to fix its execution rather than throwing more Hail Mary passes than even Doug Flutie ever completed.
Twenty months later, the results were even more obvious:
Still, let’s not put too fine a point on it: Elop’s gamble to bet the company’s future on switching to the Windows Phone platform has been an absolute disaster. … Nokia has been more successful at killing Symbian — by starving new releases — than getting people to buy Windows Phones. In fact, as late as Q2, Nokia was still selling more Symbian than Windows phones.

[R]ealistic is the advice from former Apple Europe president Jean-Louse Gasée: fire Elop and switch to Android. If Nokia’s board believed in accountability, they’d lower the axe after the end of the Christmas quarter, but more likely they’re going to limp along until they can no longer deny the reality of Elop’s failed platform strategy.
Now the Helsingin Sanomat reports in Finnish and English that Nokia is begging Elop to reduce the bonus, but Elop is blaming his estranged wife for why he can’t (won’t) do so:
Helsingin Sanomat has learned that Risto Siilasmaa, Chairman of the Board of mobile telephone manufacturer Nokia, has held discussions with former CEO Stephen Elop on either cancelling or reducing his bonus of €18.8 million.

In the discussions, Elop has brought up the fact that he has filed for a divorce from his wife. If he were to agree to relinquish his final compensation of €18.8 million during the divorce proceedings, he might still be required to pay half of the value of the bonus to his wife.

Siilasmaa does not want to comment on the matter.

AS CEO OF NOKIA, Elop travelled around the world constantly. His family lives in the United States, in Seattle, Washington.

Elop has an apartment in Helsinki, but most of his time has been spent on work-related travel. His family includes his wife Nancy and their five children.
The HS speculates that Finland might have jurisdiction over the divorce, but that seems unlikely. Instead, Elop filed for divorce Aug. 1 in King County (i.e. Seattle), and Washington State is a community property state, which means (barring other contractual arrangements) Nancy Elop is entitled to 50% of everything her husband earned during their 20+ years of marriage.

So now Elop’s failure as a CEO deserves to be rewarded because of the failure of Elop’s marriage? The one-good-failure-deserves-another warrants recognition for creativity, but not a $25.4 million (or $12.7 million) prize.

Leaks to HS are intended to put the Nokia board in the best light, by comparing Elop to his peer group — CEOs of other failed mobile handset companies:
THE PAYOUT to the CEO is exceptionally large by Finnish corporate standards.

However, compared with the golden parachutes of Nokia's international competitors in similar situations, Elop's bonus is not particularly large.

Motorola Mobility's CEO Sanjay Jha was promised a final bonus of €47 million when Motorola's telephone operations were bought out by Google.

Thorsten Heins, CEO of Research in Motion, which manufactures Blackberry telephones, is set to be paid €41 million if the purchase offer made on Monday by investors is implemented.
Tero Kuittinen of Forbes argues that Nokia’s contract with Elop gave him a powerful incentive to run the company into the ground:
According to changes implemented in 2010, Elop was entitled to immediate share price performance bonus in case of a “change of control” situation… such as selling of Nokia’s handset division. Curiously, his predecessor [Olli-Pekka] Kallasvuo had no such clause in his contract. This adjustment meant that unlike previous CEOs, Elop was facing an instant, massive windfall should the following sequence happen to take place:
  • Nokia’s share price drops steeply as the company drifts close to cash flow crisis under Elop.
  • Elop sells the company’s handset unit to Microsoft under pressure to raise cash
  • The share price rebounds sharply, though remains far below where it was when Elop joined the company.
Should this unlikely chain of events ever occur, Elop would be entitled to an accelerated, $25M payoff. Through some strange coincidence, that very sequence of events actually did happen to take place between 2011-2013. Practically instantly after Elop was handed his contract. Can you imagine how Nokia’s board must have giggled when they realized what had occurred? They had created a strong incentive for the new CEO to drive down the company share price, sell the core business to Microsoft and then collect $25M – and this actually happened!

Monday, September 23, 2013

Will Microsoft ever grow again?

In the past year, the rapid decline of the PC industry has become undeniable. The fortunes of HP, Dell and Microsoft have suffered accordingly.

Last week “Lex” at the FT questioned whether Microsoft was properly valued as a legacy IT company:

The shares trade at 11 times this years’ earnings and a free cash flow yield of 9 per cent. Cheap? Those figures look a lot like those for IBM and Oracle, the other gigantic clanking technology relics. But it is hard to argue that they face mortal threats to rival Microsoft’s.

Those who hold the stock are betting that the core businesses will be surprisingly stable, and that investors will reap the rewards. That second point is important.
With the accelerating collapse of Blackberry, Microsoft’s quixotic acquisition of Nokia’s handsets has a better chance of gaining share. However, being #3 (with a 15% share) of a low margin business is hardly going to replace being #1 (with a 80-90% share) of a business that once yielded 90% gross margins.

For the benefit of us long-suffering Microsoft shareholders, Lex recommended two steps. The first would be to shut down the online services division — including Bing — after losses last year of $1.2 billion.

This would be a monumental admission of failure — in timing, strategy and execution — to profitably enter the only software business that’s going to matter in 10-15 years. Intelligence continues to migrate to the cloud and software as a service — not software as a package or download — will be the only business of large consumer software companies. Microsoft’s exit would leave Google the sole contender for the foreseeable future, with Amazon and Apple seemingly consigned to specific niches of the business.

Steve Ballmer can’t (and won’t) admit that failure, but his successor could. Growth with heavy losses is not something that any shareholder wants, but if online services are dropped, so are any hopes of online services providing growth.

The other Lex recommendation is to reduce share buybacks (since management “has done a terrible job” of recognizing when its stock is cheap) and shift that money to increasing the dividend. As someone who owns Microsoft for its dividend (as one of the 10 Dogs of the Dow) I’d heartily endorse such a plan. With revenues stagnant and declining margins, shareholders are unlikely to see any significant capital appreciation, so sharing (rather than squandering) Microsoft’s legacy profits is best shareholders have for a return on their investment.

Saturday, September 21, 2013

Empowerment brings economic growth

There is no doubt that some are better equipped than others to navigate the challenges of the 21st century. Our purpose is not to fear or deny those inequalities – in resources, or skills, or confidence – but to understand and overcome them.

This is not a matter of more spending or more government. It requires putting members of the public in charge of their own destiny so we can prevent problems rather than just mitigating them. Such people-led politics is the way in which we save money and secure better outcomes for all. Radical and difficult to implement though it may be, it is the progressive future for which we fight.

Education policy has been defined by an obsession with who is running schools, when our children need preparation for a digital economy where “jobs for life” no longer exist.

With the pace of change in the global economy, no one can take his or her job for granted. … As the economist Adam Lent argues, the means of production are increasingly in the hands of workers. Starting a business once required considerable capital outlay. Now broadband and a PayPal account will do. Our youth embrace this. In 1998, just 17 per cent of 18-to-29-year-olds wanted to start a business –now it is 30 per cent.

This ethos hasn’t been created just by the rise of the internet. The new enterprising spirit is no more defined by new hardware than the 1980s were defined by fax machines. This is a grass-roots, pioneering mindset – and it can be harnessed by the left.
Stella Creasy, MP (Labour) for Walthamstow
New Statesman, September 18, 2013

Wednesday, September 11, 2013

Another stumble in HP's recovery

S&P Dow Jones Indices LLC announced Tuesday that HP would be among three stocks dropped from the Dow Jones index. As the WSJ reported in today’s paper:

Alcoa, a Dow component for 54 years, will be replaced by athletic-gear maker Nike Inc. Payments company Visa Inc. will replace H-P, which joined the index in 1997, and securities firm Goldman Sachs Group Inc. GS will supplant Bank of America, which spent five years in the blue-chip benchmark.
The changes take effect Sept. 20.

That a metals company would be dropped on its 125th birthday is not all that surprising. It is similarly unsurprising that a highflying New York investment bank would replace the Charlotte-based NationsBank (dba BofA), which is still struggling with its decision to buy Merrill Lynch and Countrywide near the peak of the financial crisis. (As a BofA shareholder, my attempt to bottomfish BofA in the fall of 2008 is still looking pretty stupid; if they hadn’t grabbed these two boat anchors, it might have turned out better — but then how could I know that the government would order BofA’s CEO to destroy shareholder value.)

But banks come and banks go. Hewlett-Packard is a Silicon Valley icon, by some measures the founder of the cluster — certainly the first significant Stanford spinoff and the role model for Apple, among others. The end of its 16 year run in the Dow is another sign that it’s just another struggling commodity company in a mature industry. As Bloomberg reported:
HP Exit From Dow Jones Industrial Signals Revival Challenge

Hewlett-Packard Co. (HPQ) is being removed from the Dow Jones Industrial Average, a sign of waning confidence in the company’s turnaround efforts amid an historic slump in the personal-computer industry.

The exit, announced today as part of the biggest reshuffling of the index since April 2004, delivers another blow to Chief Executive Officer Meg Whitman’s quest to revive growth at the storied PC maker.
Blogger Arik Hesseldahl notes the irony of the timing, since HP shares are up 57% this year. He won the standard non-response:
HP remains confident that we are making progress in our turnaround. We have delivered financial performance in line with or better than our expectations throughout this fiscal year, and remain focused on delivering shareholder value. We are already seeing significant improvement in our operations, we are successfully rebuilding our balance sheet, our cost structure is more closely aligned with our revenue and we have reignited innovation at HP.
Unlike leaving the S&P 500, the move has little practical impact on the shares since there are few index products built around the DJ.

Part of the problem for the three companies is that in formulating his first index in 1896, Charles Dow merely added the stock prices together (rather than using a market-cap weighting as in later indices). As the NYT notes
the Dow is calculated as a price-weighted index, so the stocks with the highest share price have the greatest weight. The three stocks that are being removed are priced in the single- or low double-digit range, putting them on the lower end of stocks in the index.

“They’ve dropped the smaller weights out of the index and replaced them with what they deem to be better candidates representing the way the economy is moving,” said Trista Rose, the global head of index strategy at UBS. “I wouldn’t say that it would have a noticeable impact on trading volume.”
For the same reason that HP at $22 is leaving the index, the world’s most valuable company won’t be joining the index. As WSJ blogger Steven Russolillo writes:
Last year John Prestbo, executive director for Dow Jones Indexes, told Barron’s that including Apple in the index would be “a methodological mess” and that Apple “certainly qualifies in every respect except one, price.”
Russolillo notes that the same argument for Apple (at $500) applies to Google (near $900).

Silicon Valley is represented by Cisco and Intel in the Dow, which also includes IBM and Microsoft and America’s two biggest telephone companies, AT&T and Verizon.

Wednesday, September 4, 2013

Handset sideshow doesn't solve Microsoft's core problems

Facing the expiration of the distribution agreement with its main mobile phone licensee, Microsoft bought Nokia. The deal fulfills Steve Ballmer’s ambition to recast Microsoft as the next Apple by allowing it to vertically integrate downstream into hardware.

Here’s the key passage from Ballmer’s press conference Tuesday:

The company I joined 33 years ago was a company focused on software for personal computers. And software is a great skill and will always be a core strength of Microsoft. The PC is an important device, the most productive device on the planet, and will continue to be so. And yet for us not only to grow but for us to really fulfill the vision of what we can do for our customers, we've evolved our thinking.

We need to be a company that provides a family of devices in some cases we'll build the devices, in many cases third parties, our OEMs, can build the devices but a family of devices with integrated services that best empower people and businesses for the activities that they value the most.
Like the dog who caught the car, now what? Microsoft under its next CEO will be a hardware company, but is there any evidence it will be a successful hardware company?

One of the problems is that Microsoft had more than a decade to offer a compelling mobile platform. Its smartphone market share has been falling since before the iPhone and Android.

Now with Windows Phone 8, it has a good product, but so what? Four years ago, another dying mobile company — Palm — brought out an innovative device to great reviews, but it didn’t matter. Less than a year later, the company — the US smartphone pioneer and onetime market leader — was gone, like Nokia bought up at a firesale price.

Microsoft has already had a chance to try its fully integrated mobile strategy with its Surface tablet, which enjoyed great reviews and a huge marketing push. In one year, Microsoft spend $900m to advertise the Surface and WP8, but generated only $850m in sales and took a $900m write-off on inventory.

Fortunately for MSFT shareholders, Nokia’s handset division is available at a firesale price, less than 10% of the company’s cash on hand. Unfortunately, the man who ran the division into the ground will be heading it for Microsoft and is now a favorite to become Ballmer’s replacement

The deal would also reward Nokia’s CEO Stephen Elop, the ex-Microsoft executive who torched Nokia’s Symbian platform in favor of Windows, and led the failed effort to regain share using Windows. (In mid-2012, Nokia’s Symbian platform had a higher market share than Windows had then or now). Elop has shrunk the company , cutting the company’s market cap in half from $40b to $20b.

Perhaps Elop won’t rewarded for his Nokia failures, but the early betting is that Microsoft’s board (a captive of Ballmer and founder Bill Gates) will pick a conventional leader who, as the WSJ put it, “won’t rock the boat.” Because of this influence, the article predicts the board will go for more of the same, someone who can run a large bureaucratic Fortune 500 company, rather than a visionary leader who will break free from the lost decade of stagnation under Ballmer. The company needs a Lou Gerstner but (at best) will end up with another Lew Platt.

The problem is, Ballmer has historically confused monopoly profits with premium pricing. People pay more for Apple products because they want to; people pay more for Microsoft products when they have to, and they don’t if there’s a good alternative.

While Nokia didn’t get software, they historically were a hardware innovator with screen, cameras, sensors and other features. Now Samsung has assumed that mantle — along with overall market share leadership — while Apple remains the software and integration leader.

The Nokia deal will reduce near-term EPS and long-term profitability ratios. The company hopes to save $600m annually, presumably by laying off 3,000-5,000 workers. I would expect most of those would be in Finland, where Nokia has for the past few year playing a shrinking role in the local economy.

Even if Nokia is a modest success, it will at best replace Microsoft’s declines in its slowly dying PC business. Buying the former market leader — which now longer even ranks in the top 10 in global market share — won’t transform it into a major player in the industry. Given its huge cash hoard, Microsoft’s phone business will last longer than Blackberry’s, but that’s not saying much.

As with all such mergers, the odds of actual success are large. Two quotes from this morning’s WSJ illustrate the problem:
When executives "can't figure out what to do, they go buy something, particularly when they have a lot of cash," says Jeffrey Pfeffer, a professor at Stanford University's Graduate School of Business. "It seldom works."

Juan Alcacer, a Harvard Business School associate professor who has studied Nokia, says companies with small market shares typically "are in a bad position for a good reason." Combining two of them, rarely works, he says: "Two bad companies don't make a good company."
The stock has given back the gains that it had with Ballmer’s retirement announcement. Hopes that Microsoft would fix its broken corporate culture, becoming faster and more responsive are now dashed. We long-suffering Microsoft shareholders own a utility, that pays out a fraction of its declining monopoly profits with no replacement in sight.

Monday, September 2, 2013

The ignominious end of Nokia's handset hegemony

On Tuesday morning (Finnish time), Nokia announced that it was selling its handset business to Microsoft for €5.44b. The payment includes €3.79b for the division and €1.65b for a 10-year (non-exclusive) license to the Nokia patents necessary to operate that business. The deal is funded by Microsoft’s offshore profits that (as with most US-based multinationals) it has been unable to repatriate due to the US tax law.

A PDF published by Microsoft summarizes the deal:

  • Microsoft acquires Nokia’s phone business
  • Microsoft acquires Nokia’s Qualcomm, other key IP licenses
  • Microsoft licenses Nokia’s patents for use across all Microsoft products
  • Microsoft licenses ability to use Nokia HERE broadly in its products
  • Nokia retains NSN [Nokia Siemens Networks], HERE, its CTO Office, and its patent portfolio
  • Nokia and Microsoft cement original partnership with this deal before 2014 recommitment date
As a Microsoft shareholder, this seems like a final failed effort by Steve Ballmer to make big strategic moves to distract from the failure of his efforts to execute on the core businesses he inherited when becoming CEO in 2000.

Want proof? In the same PDF, Microsoft projects in 2018 an “assumed market share” of 15% for the Nokia (or Windows Phone) business. Microsoft hasn’t had 15% share since 2005, and its most recently quarterly share (like Nokia’s) was under 4%. As with all of Microsoft’s mobile strategy since then, the deal is more about hope than feasible strategies.

About the only good news is that the troubled Microsoft is acquiring the even-more-troubled Nokia for a song. Three years ago, Nokia’s handset division was grossing more than €6 billion per quarter; two years ago, Microsoft paid 20% more to buy Skype, a company without a business model.

Meanwhile, what about Nokia? Basically, its current and previous CEO have panicked as they have driven the company into the ground. Since the 2007 introduction of the iPhone, bought full control of Symbian Ltd. (and then killed it), switched from the once-dominant Symbian to the also-ran Windows platform, and now is exiting the business. All this from the company that was the world’s largest handset maker from 1998 until 2012.

The urgency of the deal for Nokia is evidenced by the key financial terms. Microsoft is “immediately” advancing Nokia €1.5b so it can keep the doors open until the deal closes — and Microsoft presumably assumes the salaries of 32,000 Nokia employees in the money-losing division.

It’s hard to see how losers buying losers (cheap) creates a winner. Yes, the mobile market is growing as Microsoft’s core business is dying. Yes, having a captive† handset manufacturer will justify keeping open the Windows Mobile division. But how will having a distant third place product with single-digit market share solve Microsoft’s numerous growth and profitability problems?

† Microsoft claims other licensees will continue, despite decades of failed licensing efforts by vertically integrated platform owners. Licensing didn’t work for Nokia with Symbian, didn’t work for Palm with Palm OS, didn’t work for Apple with Mac OS 8, and didn’t work for IBM with OS/2.