Delvalle: How Bad CEOs Destroy Good Companies

A very nice article to read...  just to share (they  say, sharing is caring), hemm!

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Dear IF Reader,

In the business world, if you can’t execute, you risk losing a lot of money.

But if your ideas are flawed to begin with, no amount of skilled execution will make them work.

And the same thing applies to stocks. If you buy into a stock that has executives brimming with lousy ideas or without the acumen to execute themselves out of a paper bag, you will lose a lot of money.

One story I can tell you involves Sprint PCS (S).

I had a Sprint phone about ten years ago. The phone itself wasn’t bad, but the service it came with was the worst I ever had. I experienced multiple dropped calls. Voice mails wouldn’t show up for days. I even had to call the company every other month to argue about erroneous billing errors.

I returned the phone and cancelled the service in disgust.

Of course, I wasn’t the only one. Sprint’s stock price dropped as the company lost customers.

Poor execution was costing the company. And its very ability to flip a profit was at risk. But then Sprint hired a new CEO. And he seemed to be righting the ship. Customer-feedback surveys improved. And the company started gaining subscribers.

But the good times didn’t last long.

You see, when you run a wireless telecom like Sprint, it costs billions of dollars to adopt new technology to improve service.

In 2006, Sprint decided that it wanted to upgrade its third generation (or 3G) wireless data network with a fledgling 4G technology called WiMAX. It would cost $2.5 billion to upgrade its towers across the U.S. Now, that’s a lot of money. But, if successful, it would put Sprint ahead of competitors like Verizon and AT&T Wireless. They weren’t planning on rolling out 4G for years.

But things never panned out the way Sprint expected. As soon as it started the rollout, WiMAX was plagued with problems.

First, network performance was never stable. If you drove down the strip in Las Vegas, download speeds would vary from 1-2mbps (slower than 3G) to 11-12mbps (which is similar to a cable Internet connection). Even my sister-in-law, who uses Sprint’s wireless data service, complains about how slow her connection is indoors.

The mixed reviews Sprint’s 4G network received didn’t encourage consumers to adopt its technology.

Second, phones that ran on WiMAX were hard to come by. Manufacturers didn’t want to waste money making them, especially if consumers weren’t willing to buy. So fewer phones were made. And the ones that did hit the store shelves suffered from battery drain problems.

Third, the entire industry began moving to a better 4G technology called LTE, which promises faster speeds than WiMAX and a steadier download rate. Sprint now finds itself behind the curve. If it doesn’t adopt the new 4G technology, it will be saddled with an inferior service… and lose money as a result.

In essence, Sprint’s investment turned into a massive waste of cash. This makes WiMAX the worst idea the company’s executives ever came up with. The execs should have known better. After all, even in 2006 most telecom companies understood that WiMAX had some potentially disastrous problems.

Now reports are hitting the wire that Sprint will abandon its WiMAX technology and upgrade to LTE. Can you believe this? It will push Sprint’s spending projections through 2013 from $3 billion all the way up to $10 billion!

Sprint doesn’t have that amount of spare cash. It’ll have to go to investors sometime next year and ask for more. Good luck with that in the economy we have today.

If Sprint manages to get more cash and the economy gets worse next year, it could pay much higher interest rates. If it fails to get the investment it needs, it would keep losing money and probably be forced into bankruptcy.

The company’s ideas were simply awful. And stockholders are paying the price. Shares are down more than 50% since June.

But Sprint isn’t the only company that is suffering from bad ideas and poor execution. In the past year alone…

- Hewlett Packard spent $1.2 billion to buy PALM, only to barely invest any money in product development. HP released phones and tablets that weren’t competitive with Apple or Google. Now, it’s mulling selling its stake or spinning it off into a new company.

- RIMM released a new smart phone operating system meant to take away business from Apple and Google. Too bad it released the software too early, without access to the applications Blackberry users actually access the most. RIMM shares have fallen 64% since February 2011. Clearly, investors aren’t impressed with the company’s execution.

- Netflix recently raised the price of its streaming and DVD rental service by 60% for most users. But here’s the real mess-up: After the price hike, the company announced it was splitting its DVD business from its streaming business. The uproar was huge. Since then, the CEO announced that (on second thought!) the split would no longer occur. But the damage was done. Shares of Netflix have dropped 63% since July.

What this tells you is that a company can only be successful if it 1) has good ideas and 2) executes those ideas well.

Good ideas alone aren’t enough. The executives running the company have to be good at executing their strategies. Or else they could wind up like HP did when it wasted $1.2 billion buying a company that it acted like it never really wanted.

When it comes to companies that deserve your money, good ideas and proper execution go hand in hand. So it’s imperative to look for a company with executives who have a good record of doing both.

Of course, not every company is perfect. Even the best executives mess up sometimes.

Take the former leader of Apple, the late Steve Jobs. Not every product he introduced was a hit. But he never let those failures stop him from introducing something new. Because of his exceptional executive skills, the company now has enough cash to completely bail out Greece if it wanted to.

So don’t confuse chronically bad execution with the occasional bad decision. Let me give you one more example of what I mean.

Alan Mulally, head honcho at Ford, is another good executive who makes the occasional boneheaded mistake. Just because he goofed by putting complicated technology into cars (which has cost Ford some quality points on surveys like the one from JD Power and Associates), his leadership allowed the auto company to become the only domestic car manufacturer that didn’t need a bailout.

So every time you think of buying a stock, be sure to ask yourself: Do the leaders of the company have a track record of coming up with great ideas? And do they have a knack for properly executing them?

If the answer is “no” or “every once in a while,” stay away.

But if you find that the company has executives who know how to come up with breakthrough ideas and execute them flawlessly, you’ve just found a great reason to buy into it.

Take care,

Charles Delvalle

Financial Analyst

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