by Scott Fearon
I’m not knocking Rob for his good taste in clothing or offices. But neither his suit nor his work environment, not to mention his bullish demeanor, gave me the sense that he had a clear view of the disaster his company was facing. As I went over BMHC’s horrendous financial statements with him, I remembered the old story of Emperor Nero practicing his fiddle while Rome burned. Rob clearly wasn’t as incompetent, or depraved, as Nero. He’d helmed BMHC for a decade by then; under his leadership, it had grown from a regional outfit to the sixth-largest lumber and building materials company in the country. But it had done so by following the dangerous formula of hypergrowth. Rob and his predecessor as CEO had boosted the company’s balance sheets (and stock price) by taking on debt to buy out dozens of smaller competitors. The formula worked well during boom times, when BMHC could service that debt with growing profits. But as soon as things turned and revenues declined, all that leverage suddenly teetered over the company like one of the towering Northwest conifers Boise Cascade felled by the thousands during its heyday.
Making matters worse, BMHC was still primarily a commodity-driven business. It might have been easy for Rob and its other executives to forget, on the thirty-second floor of one of San Francisco’s most exclusive business addresses, but the firm made its money framing up suburban tract homes and wholesaling low-margin commodities like plywood, drywall, and roof shingles. That is a brutal, highly volatile industry. One two-by-four or bag of concrete is identical to another, and developers aren’t going to pay more for them just because they like you or you wear an impressive suit. For BMHC, like every other commodity business, the only way to compete is on price. That’s hard enough to do, but it’s downright impossible when you’re carrying exorbitant administrative expenses—like, say, hundred-dollar-a-square-foot waterfront office space—or you’re paying your top executives enough to dress like they just stepped off a runway in Milan. Rob’s total annual compensation was reportedly well into seven figures.
I wasn’t the only person in the investing world concerned about the gulf between BMHC’s rapidly declining finances and its leadership’s lofty lifestyle. Just a few months before I visited Embarcadero Center, a money manager in Los Angeles named Robert Chapman had taken advantage of BMHC’s plummeting stock price to acquire more than 7 percent of the company. Chapman has never been shy about criticizing the managers of businesses he invests in, but he was particularly pointed with the brass at BMHC. He took to publicly calling out Rob as “San Francisco’s own $6 Million Man” and urged the company to reduce “its bloated cost structure.”*
Even as the housing crisis became a clear supercycle event, BMHC—again, a low-margin commodity and service provider with its roots in Boise, Idaho—kept its tony corporate headquarters on the San Francisco waterfront. That fact alone, even more than the firm’s increasingly gruesome finances, convinced me to short its stock. Relatively speaking, the expense of maintaining the San Francisco office might have been small compared to BMHC’s overall budget, but the symbolism of it was enormous. It displayed a leadership that was, quite literally, out of touch. Responsible managers would have already moved themselves into much humbler surroundings. There was no reason Rob and his fellow executives couldn’t conduct their business in a low-cost industrial park or even some modest mobile offices tucked into the corner of one of the dozens of lumber supply yards the company owned. That would have not only saved crucial overhead expenses during the housing crisis, it would have shown the world—and their own employees—that they were going to do everything it took to weather the downturn, even if it meant living and working (gasp!) outside of San Francisco.
Eventually, in early 2009, BMHC did move its headquarters back to its original hometown of Boise, Idaho. But by then, it was too late to save the business. The New York Stock Exchange had already delisted its stock. Six short months later, BMHC filed for bankruptcy and its stock went to zero. The company emerged from Chapter 11 in much better shape as a private concern. Not surprisingly, Rob did not make it through the reorganization. He stepped down as CEO and was replaced by someone making a fraction of his salary. I haven’t been to visit this new CEO’s office in Boise. I’m sure it’s not quite as impressive as Rob’s old suite in Embarcadero Center. Then again, I’ve been to Idaho and it has plenty of breathtaking scenery, too.
The Emperor Wears No Clothes (and Doesn’t Sell Any Either)
A euphemism that gets thrown around a lot in the corporate world is disruption. New technologies or services are said to disrupt existing industries, forcing businesses to adapt or perish. While many people act like this is a new phenomenon birthed in a garage in Silicon Valley, it’s actually a very old process. Almost every business faces some kind of disruptive event in its lifetime, and it’s up to its managers to make sure that it evolves and continues to compete. But when those managers don’t disrupt their own lifestyles to bring the changes about, their efforts are almost always doomed. It’s like trying to lead a cavalry charge from behind. If you’re not willing to take a bullet yourself, you’re not going to inspire many people to follow you into battle.
Several years after my experience with BMHC, the board of the department store giant JCPenney handpicked another affluent Bay Area executive, Ron Johnson, to be its CEO. The hire was hailed by Wall Street and the media, and JCPenney’s stock shot up five points on the day of the announcement. At that point, Johnson was the darling of the business world. He had built Apple’s retail stores into a juggernaut, and people were understandably optimistic that he could revamp the old department store chain as well. But I remember hearing something at the time that kept me from sharing in this positive outlook: when he took the job, Johnson refused to move near the company’s headquarters in Plano, Texas. Instead, he kept his house in a high-rent Silicon Valley suburb. Later it was revealed that he flew the three-thousand-mile round-trip each week on the company’s private jet and stayed at the exclusive Dallas Ritz-Carlton on JCPenney’s tab.
As I mentioned in chapter 3, a few months after Johnson’s firing, I visited JCPenney’s Plano headquarters and spoke with a top executive. He pointed out the window toward a perfectly decent midrange hotel across the freeway from the campus. He said he could have reserved the nicest suite they had for Johnson at that establishment. For the money it cost the company to put Johnson up at the Ritz-Carlton, he probably could have rented out an entire floor.
As with Rob at BMHC, Johnson’s decision to keep his residence in the Bay Area and stay at the Ritz was largely symbolic. At the time of his hiring, JCPenney had over $17.7 billion in annual revenues, and in this day and age, it’s technologically feasible for a top executive to commute halfway across the country. For those reasons, many JCPenney bulls dismissed Johnson’s refusal to move to Plano as insignificant. But his imperial attitude reminded me of Rob, who was running what amounted to a lumber company from the Financial District of San Francisco. That sort of elitism rarely sits well with workers, middle management, or even other executives, and it almost always leads to internal problems. In Johnson’s case, it was also a harbinger of something else, which I discussed in chapter 3: his utter cluelessness when it came to the chain’s working-class customer base. While that is what ultimately led to his firing, his self-imposed distance from his own workers might have been just as corrosive. You can’t make major changes in a company with thousands of employees unless you connect with them directly and earn their loyalty. That’s all but impossible when you’re literally looking down on them from thirty thousand feet.
Big Brother
Johnson didn’t help his elitist image when he reportedly started sending out monthly video addresses (many of them taped from his living room in California) and requiring JCPenney employees to watch them.* That wasn’t just imperial, it was downright Orwellian.
Can you imagine being a busy department manager at a store in Lawrence, Kansas, or Columbus, Ohio, and having to take an hour of your day to watc
h a video of some millionaire in Silicon Valley who purports to care about your company but can’t even be bothered to live in the same town as its corporate headquarters? I can’t either, and that’s why I wasn’t surprised to see Johnson’s grand experiment at JCPenney fail spectacularly. I even made a little bit of money shorting the company’s stock as it fell.
*Kim Bhasin, “Ron Johnson’s Desperate Broadcasts to JC Penney Workers Fell Flat as Company Faltered,” Huffington Post, May 28, 2013.
Johnson was relieved of his duties at JCPenney a short eighteen months after he took the job. Despite his brief tenure, he managed to bring the century-old retailer to the brink of bankruptcy. In a single year, the company lost well over $1 billion.
As hard as I’ve been on Rob at Building Materials Holding Corporation and Ron Johnson at JCPenney, you might find it surprising that I don’t blame them primarily for their companies’ failures. They might have been aloof, but they weren’t dishonest or immoral. In fact, they were perfectly upfront about their plans and their priorities—which is why it was shocking that they were hired to begin with, or left in place as long as they were. Then again, the very boards of directors who brought them on were clearly just as out of touch with their businesses as they were. A famous New York hedge fund manager named Bill Ackman, who had a major stake in JCPenney, was responsible for Johnson’s hiring. He, like Johnson, wanted to remake JCPenney into a place where coastal elites like him could feel comfortable shopping, despite the fact that most of the thousand-plus stores were in working-class areas in the middle of the country.
Like Rob managing a lumber supply company from the rarified air of San Francisco’s Financial District, JCPenney’s directors failed to venture beyond their own insulated perspectives when they hired Johnson. Instead of finding someone who understood the company’s core customers and business model, they turned the company over to someone exactly like them. That shortsighted nepotism nearly bankrupted one of the largest and most storied retailers in the country’s history.
JCPenney was far from the first company to go south because its directors chose an absentee chief executive with no grasp of a business’s culture or customers. I’ve seen this phenomenon a number of times over the years, and it almost always ends badly—not just for the companies, but often for the directors and executives themselves. One of the most infamous examples took place back in the late 1980s when the San Francisco investment bank Hambrecht & Quist—which specialized in rehabbing troubled tech companies—acquired a major stake in a struggling disk drive manufacturer called MiniScribe.
A few years earlier, IBM had dropped MiniScribe disk drives from its PCs, almost killing the company. But Bill Hambrecht, a revered figure in the investment world, believed it could come back. He convinced his fellow directors on MiniScribe’s board to hire his personal corporate “Dr. Fix-It,” a man named Q. T. Wiles, to make it happen. Wiles had previously turned around several other Hambrecht & Quist investments. But MiniScribe was a different kettle of digital fish. For one thing, it was larger than any of the other companies Wiles had managed. It was also headquartered in Longmont, Colorado, a suburban community about as far away from Denver as Plano is from Dallas. Wiles didn’t want to leave his home in the Los Angeles area, so, like Ron Johnson, he tried to run the business from afar. He reportedly traveled to Longmont once a quarter or less. But even though he wasn’t physically in their offices, his intense leadership style created so much pressure on MiniScribe’s executives that they began to falsify their accounting records to meet his aggressive revenue goals. At one point, they became so desperate to boost their sales figures, they began to ship packages full of bricks instead of disk drives!†
These frauds went undetected long enough for MiniScribe’s finances—and its stock price—to recover briefly. Wiles was credited for rescuing another faltering business. The celebratory champagne went flat fast, though. After the company announced big losses, MiniScribe’s creditors and shareholders sued over its cooked books. They also sued Hambrecht & Quist and both Bill Hambrecht and Q. T. Wiles personally. A civil jury eventually awarded the plaintiffs $550 million. Hambrecht & Quist, once one of the most powerful investment firms in the country, almost went bankrupt as a result. Bill Hambrecht’s reputation was tarnished, but he got off relatively easy compared to his old friend Q. T. Wiles. In 1994, Wiles was found guilty of fraud and insider trading.‡
The Blame Game
Corporate leaders don’t have to live thousands of miles from their jobs to be woefully out of touch with the fortunes of their own companies. I’ve seen lots of committed, hands-on executives make the same mistake but for a different reason. They haven’t been as aloof as Ron Johnson or Rob at BMHC, but they’ve been just as unwilling to admit their own shortcomings. During hard times, they’ve pointed to all sorts of reasons for their business’s troubles when they really should have turned their fingers on themselves.
I am intimately familiar with this tendency to deflect responsibility. While my first restaurant was losing thousands of dollars a week, I identified all sorts of culprits for its troubles—my unreliable staff, the cost of food, the fickle habits of my customers—instead of recognizing the root of the problem from the very beginning: my insistence on serving Cajun food in an area that would never warm to that cuisine.
People don’t like to face bad news, especially when it means admitting that they’ve made stupid decisions. They invent all kinds of rationalizations to keep from owning up to their culpability. Worst of all, they tend to blame anything and everyone but themselves for their failures. The Bible says, “Pride goeth before destruction.” I think they should put that quote in business textbooks, because pride often goeth before bankruptcy, too. If you’re not willing to admit your own mistakes and misjudgments, you’re going to eat them for lunch.
Back in 1991, the first year I started my hedge fund (and right around the time Bill Hambrecht and Q. T. Wiles were in court dealing with the MiniScribe debacle), I paid a visit to a tech company in San Jose called Consilium (stock symbol: CSIM). Consilium built a software product that controlled automated factory operations—the robots that soldered components to computer motherboards and painted new cars on assembly lines, things like that. I’d been studying the numbers and noticed that its debt levels were getting dangerously high at the same time as its revenues were flattening out, so I got in my car and tooled down the peninsula to its headquarters. I met the company’s chief financial officer, Mark, who had a ready answer for Consilium’s troubles.
“It’s very simple, Scott,” he said. “It’s all about M-1.”
“M-1?” I asked. “What do you mean, M-1?”
“M-1,” Mark repeated. “The aggregated monetary supply. The Federal Reserve has been constraining it over the last two quarters so factories aren’t spending like they used to. That’s why sales have been flat.”
“Hold on,” I said. “M-1 is literally trillions of dollars. You guys do like ten million a quarter in sales. You don’t think your problems might have something to do with the quality of your products or what your competitors are doing?”
“Oh no, absolutely not, Scott,” he said. “We’re rock solid. It’s the Fed. I’m telling you. They’re killing our business.”
I shook his hand, drove back to my office, and immediately shorted Consilium’s stock. It was trading at $17 at the time. Over the next year, the company’s revenue growth continued to disappoint and its share price turned south. I covered my position at just under $10, but the stock continued to trend down after I got out. In 1998, technology giant Applied Materials acquired Consilium for about $7 a share.
As soon as Mark started spouting off about M-1, I knew Consilium was in trouble. It was obvious that he was looking for any excuse he could find for their problems instead of facing up to the simplest, most obvious explanation: they were selling an inferior product. Like so many other people I’ve see
n in failing businesses, Mark kept casting around for something on the outside to blame when he should have seen where the real problem was—right there inside his own shop.
Sure, macro events like M-1 can affect a business, especially a large business like Oracle or Microsoft or Ford Motor Company. My first employer, Texas Commerce Bank, was one of the most profitable banks in the country before the price of oil collapsed. That massive reversal crippled the company, and scores of others. But the idea that some small variation in the country’s multitrillion-dollar money supply would significantly swing the fortunes of a pipsqueak tech firm with a couple million in revenues was laughable. This was reinforced by the fact that, despite Mark’s reasoning, Consilium’s main competitors were doing fine at the time. Their sales and revenues hadn’t been affected by the far-off decisions of central bankers in Washington. And yet, I still remember the look in Mark’s eyes as he told me about it. He wasn’t lying or spinning some tale for me. He really believed what he was saying.
