Friday, September 23, 2011

HP: Evaluating Meg Whitman's Track Record

Hewlett-Packard's former CEO Leo Apotheker was essentially fired from his position yesterday after only 11 months on the job. He was immediately replaced by Meg Whitman, because (according to HP's press release), she is a "technology visionary" and "a strong communicator who is customer focused with deep leadership capabilities". Clearly, these are rather subjective attributes, and no effort was made to back up these claims.

It strikes me as odd that the board made no effort to justify the hiring on the basis of the metrics that should appeal most to investors: the manager's ability to generate returns on capital. The media's reaction has been no better; the articles discussing Whitman's hiring appear to be focused on HP's languishing stock price and regurgitating the subjective criteria attributed to Whitman in HP's release.

Often, it can be difficult to evaluate a manager. If the manager led a private company or led parts of a public company but in a subordinate role or led a company for only a short period, we may not have enough information to determine the manager's effectiveness. But in Meg Whitman's case, we have a plethora of data at our disposal. This is because she was the CEO of eBay from 1998 to 2008, which can give us great insights as to her effectiveness as a chief executive.

At first glance, it may look like she did an extraordinary job. Consider eBay's growth in shareholder equity over the period in which she presided:

Clearly, eBay grew by a lot over this period. Unfortunately for shareholders, however, it was not exactly profitable growth. Surprisingly, here's what eBay's return on equity (ROE) was over that same period:

In other words, returns were pretty mediocre, essentially generating something pretty close to their cost of capital: over Whitman's decade-long tenure heading eBay, return on equity averaged just 7.9%. The growth in shareholder equity depicted in the first chart above was the result of share issuances and share-based acquisitions, but the return numbers show that little in the way of value was actually added for shareholders!

To the media and the financially illiterate, all growth looks good. To value investors, however, it's clear that the actual returns were unimpressive. This helps explain why the company's stock price is not far from its highs in 1999 and 2000, and why it still trades well below its average price in 2004.

Though ROE starts looking good in 2008, this is because the company took a large Goodwill write-down in 2007 (related to its 2005 acquisition of Skype). This serves to raise ROE in 2008 and subsequent years due to the lowered level of equity.

One could probably also argue that considering eBay's competitive advantage during this period, the company's financial performance should have been a lot better. eBay enjoyed certain network effects that gave it an advantage over its competition. You wouldn't know it from those return numbers depicted above, however.

The fact that eBay's board rushed to hire someone with such a mediocre track record is puzzling. Hopefully, they do have some reason to hire Whitman that is grounded in fact and data, and not just because she is a great saleswoman who was able to convince others that she is "a strong communicator who is customer focused with deep leadership capabilities" to quote from HP's press release.

Regarding Apotheker's ouster, is 11 months really a long enough period in which to evaluate his performance? I would argue that the answer is no. In large organizations, it often takes years to see the results of strategic decisions. For example, Steve Jobs officially became Apple's CEO in the year 2000. But it wasn't until 2005 that Apple's ROE and ROA rose above 10% (and have stayed there ever since).

It also appears unlikely that Apotheker was fired because of strategic disagreements with the board, either. As Whitman took the job, she re-iterated HP's desire to spin off the PC business and to press forward with its multi-billion dollar purchase of Autonomy.

So if Apotheker wasn't given enough time, and if there were no strategic disagreements, why was he fired? It appears likely that HP's board reacted to HP's stock price. Evaluating a manager's performance based on the company's stock price sounds like a very poor idea, particularly over a time frame as short as 11 months! A lot of factors irrelevant to the company's actual performance get incorporated into stock prices, including macroeconomic factors and investor perception/confidence.

However, based on the board's subsequent hiring of Whitman, perhaps the board's actions shouldn't be all that surprising. This board appears to give undue weight to factors unrelated to long-term returns on capital. Meg Whitman is probably a great saleswoman, who convinced her fellow board members that she is the right person for the job. Her track record in a previous stint as a CEO of a billion-dollar firm, however, suggests otherwise.

Disclosure: No position

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