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September 05, 2006

How to Tell When A Management Team Is Covering Its Ass

posted by MR WAVETHEORY at 9/05/2006 09:54:00 PM
When a management team covers up bad news in the form of a positive press release, I find it very disturbing. How do you tell a good management team from a bad management team?

1) A good management team will guide down the numbers for its shareholders before the bad news arrives. Bad teams wait until the last minute. An example of a great management team is Microsoft. It is one of the most well run companies in the world. Microsoft has rarely blindsided investors with overly optimistic guidance. And during the dotcom correction, it guided expectations down - prior to announcing earnings. That is why it is so easy to tell the good guys from the bad guys. Good teams face the facts and tell the story like it is, so that shareholders can make the decision as to whether to buy, sell, or hold. When the bad news arrives, a good management has already disclosed the problem. Rather than talking about the past, it is already talking about the solution, and the future.

2) A good management will be forthcoming about the extent of the bad news. Nobody is perfect. However, it is surprising to me how many large Fortune 500 companies are not forthcoming about the extent of bad news. Remember Google's earnings miss two quarters in a row or Yahoo!'s earnings disappointment? These were wipeouts for the average investor, who lost a signifcant amount of wealth in each case. These are hard earned dollars, and managers have a responsibility to shareholders. The difference between a good management team and bad one is that good management teams know how bad the situation is, and communicate it directly. A bad management team will waddle around, providing overly optimistic guidance to the board, until the proverbial sh*t hits the fan - and until it's too late.

3) Finally, good management teams work for shareholders. Bad ones leave shareholders out to dry. This is most easily seen when looking at stock options transactions and allocations. When you look at the Rule 144 filings of executives, do you see the management team time and again selling their options heavily prior to announcing the bad news? Or did they give shareholders and owners an equal opportunity?

Being able to tell good management from bad is a key skill for investors. Take for example, the company Cryptologic Inc (CRYP), a provider of online poker software to several major online casinos. The company has known for several quarters that it will lose its largest customer, Betfair. Rather than disclosing the extent of the potential loss of business, insiders have been selling shares while trying to downplay the extent of the loss. In fact, when Cryptologic finally conceded today that Betfair will be leaving, the management team tried to downplay the issue saying "CryptoLogic Confirms Previously Announced Betfair Exit". Cryptologic has yet to disclose how much business it will lose to investors.

Management's lack of transparency leads me to 2 different conclusions: either they have no clue about the extent of the loss, or they do, and they don't want to admit it. I am fairly certain they know the extent of the loss, but just don't want to admit it.

Knowing that investors are very concerned, I find it very disturbing that Cryptologic paper overs the issue rather than facing the facts, procrastinates until the last moment to announce the bad news, while withholding from investors material information about the business.

Now that you know how to tell a good management team from a bad management team, you can apply it the next time you come across a lemon.

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