Cogent has warned of challenges it is facing in its business.  In parallel, it has been buying back its stock and debt–both of which are priced at a sharp discount to 2007 values.  The past few posts have discussed the context around the situation.   Yesterday’s post “Both Overvalued and Undervalued is Bad” explained Warren Buffett’s principle that the job of a CEO is to ensure stock price reflects intrinsic value.  I ended with the point that Cogent’s actions might be appropriate despite the apparent contradiction of the Oracle’s point.

Let’s assume Cogent has very real concerns about the challenges its business is facing.  If so, it is their responsibility to share these concerns with shareholders.   More important now than ever is not to hide such challenges from shareholders.  The CEO owes its shareholders this information.  It should be disclosed.

Let’s also assume that Cogent has been very clear that it is purchasing equity and debt on the open market.  I’ll use stakeholders to refer to both equity and debt holders.  Stakeholders have this information, along with Cogent’s warnings, and can factor it into their decisions to buy or sell.  Presumably the fact that Cogent is buying props up the value of the debt and equity.  Stakeholders who disagree with Cogent’s assessment of its value are thus able to sell at a higher price.  They likely appreciate that this option is available and they likely know their exit price would be lower if Cogent wasn’t buying.

Key to this discussion is that no one knows what the true value of Cogent really is.  Management has an opinion.  Certain investors of Cogent might disagree with management and therefore choose to sell even knowing that the company and its CEO are buying. After all, it is differences in opinion about the value of a company that determines stock price.

Here is the core issue though that troubles me a bit.  Cogent is putting itself in a difficult-to-navigate position.  Let’s assume Cogent believes in Warren Buffett’s principle that Cogent’s goal should be that Stock Price = Intrinsic Value.  By being a buyer while warning of business challenges creates the appearances of conflict of interest.  One could argue that the appearances is reason enough to not be buying securities while warning of bad results.

I stress again though that those who want to sell might fevorishly disagree.

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Overvalued and Undervalued Stock Price are Both Bad
Buying Back your Stock on the Cheap
Ethics of Stock Price Management
High Stock Price = Bad (sometimes)
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[Continuation of Ethics of Stock Price Management].

Warren Buffett promises to his shareholders that his goal is for Berkshire Hathaway’s stock price to reflect the Intrinsic Value of the company.  Buffett playfully cautions shareholders that this means his goal is not for stock price to be as high as possible–instead, he wants it to be a fair price.

Buffett explains he wants to give all his shareholders a fair shake–both existing shareholders as well as future ones.  He does not want one class of shareholders (those who own the stock today, for example) to make money at the expense of another class of shareholders (that is, those who buy the stock tomorrow).

The Oracle calls this Berkshire’s its-as-bad-to-be-overvalued-as-undervalued approach.

So let’s apply this to Rob Powell’s recent post on Cogent.  Cogent is warning of challenges it is facing while buying up stock and debt.  Many other companies paint an optimist view of their future while selling securities.  “Aren’t these the mirror image of each other?”, Rob asks.

Well, for reasons perhaps different than what Rob was implying, the answer according to Mr. Warren Buffett might be yes.  Both might be possible violations of Buffett’s “It is as bad to be overvalued as undervalued” principle.  Both could result in the shifting of value between classes of shareholders.

Cogent certainly believes it is worth more than its public enterprise value; else it wouldn’t be buying back its equity and debt.   If Cogent is right, value is shifting from old stakeholders to remaining ones.

However, please do not interpret this post as a suggestion that Cogent is doing something inappropriate.   In fact, many might conclude their actions are highly appropriate given the circumstances.  I will discuss this more in tomorrow’s post.

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High Stock Price = Bad (sometimes)
The Appearance of Conflict of Interest
Ethics of Stock Price Management
Buying Back your Stock on the Cheap
Maximize Intrinsic Value, not Stock Price

Yesterday’s post was titled “Buying Back your Stock on the Cheap“.  The post covered a situation where a company is warning the public markets that business is bad.  The stock price and debt have fallen dramatically.  In the meantime, the company and its CEO are buying equity and debt.

Rob Powell of Telecom Ramblings posed the question of how should we view this relative to the mirror image–when companies talk-up their companies and then raise money at higher prices (or personally sell their shares).   What is the ethics of each scenario?

This is a question that Warren Buffett answers oh-so-well.  Many months back, I wrote a post on the topic called “High Stock Price = Bad (sometimes)“.  This is a hugely important topic and I encourage my co-workers (particularly executives) to read it carefully.

The gist of Buffett’s point is this:  executives should aim to have their stock price reflect the intrinsic value of the company, not more and not less. The Oracle of Omaha cautions his shareholders that this means he does not view his mandate to get the stock price to be as high as possible; instead, his promise centers around the goal of having the stock price reflect intrinsic value.

This is in contrast to how many executives view their job: they believe the goal is to get their stock price as high as possible.   On one level, they are right.  On another level, they are wrong and the mistaken notion could lead to dire consequences.  The executive must understand the subtle but all-important nuance in the principle that Warren Buffett holds so dear to his heart.  My answer to Rob Powell’s question lies in the Oracle’s wisdom.

I will pick this up Thursday.

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Maximize Intrinsic Value, not Stock Price
Overvalued and Undervalued Stock Price are Both Bad
High Stock Price = Bad (sometimes)
Stock Price provides Insight into Intrinsic Value
Does Stock Price reflect Intrinsic Value?

A week or so ago, Rob Powell posted Cogent, Self Promotion, and the Mirror Image.  In the post, Rob asks (me paraphrasing):

What happens when executives talk their company down, and then buy the stock or debt at a substantial discount on the open market?

The situation that led to Rob asking this question is Cogent.  Since May, Cogent has been communicating that business is not so good.  Growth in traffic has slowed.  Price competition is fierce.  And Cogent has no choice but to aggressively lower their price.  Not surprisingly, their stock fell sharply–it is 75% lower than its 2007 price–and their convertible debt has been trading at an enormous 50% discount.

In the meantime, Cogent has been using its excess cash to buy stock and debt.  Evidently, they believe their company is worth a lot more than the public markets. In addition,  Cogent’s CEO is personally purchasing debt at this steep discount.

Rob Powell contrasts this situation to its mirror image.  He opines that CEOs often pump up their stock price, thereby enabling them to raise money at higher prices or sell their shares at inflated prices.  Rob asks “are the ethics different when we look at a mirror image?”.

I will provide my perspective to this question tomorrow.

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Overvalued and Undervalued Stock Price are Both Bad
Ethics of Stock Price Management
The Appearance of Conflict of Interest
Stock Price provides Insight into Intrinsic Value
High Stock Price = Bad (sometimes)

Is the job of a CEO to make the stock price as high as possible?  Hmmm.  If that sounds like a trick question, that’s because it is.  The answer, according the the Oracle himself, is no.  Having lived through the Telecom Boom and subsequent meltdown, I appreciate the imporance of this issue.

Buffett is the CEO of Berkshire Hathaway.  He tells his shareholders that he aims to have his stock price reflect the intrinsic value of his company, not more and not less.  His reasoning is that he does not want one class of shareholders (those who own the stock today, for example) to make money at the expense of another class of shareholders (that is, those who buy the stock tomorrow).  He desires his shareholders to record a gain or loss in value during their period of ownership that is proportional to the gain or loss in per-share intrinsic value.   He calls this Berkshire’s its-as-bad-to-be-overvalued-as-undervalued approach.

When it comes to value creation, the job of the CEO is to maximize Intrinsic Value.  If the company does a good job at this, it will produce a growing stock price.  But this principle (beyond just its merits from a fairness perspective) emphasizes that the focus needs to be on intrinsic value, not stock price.  It also puts a spotlight on the CEO’s job to communicate what he or she believes the true Intrinsic Value of the firm.

How many times during the bubble did executives seem to focus more on hyping their performance?  If the group was committed to Buffet’s stock-price-reflects-Intrinsic-Value principle, would the bubble would have been nearly as pronounced?  Would shareholders who exited in 2000 have benefited at the expense of those who dived in during 2001?  We will discuss accounting issues in subsequent blogs–but might have their been less accounting shenanigans had this principle been fully embraced.

Answers to this enormously tough quiz:  Most of the time; Probably Not; Certainly Not; I Doubt It.

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Maximize Intrinsic Value, not Stock Price
Overvalued and Undervalued Stock Price are Both Bad
Ethics of Stock Price Management
Does Stock Price reflect Intrinsic Value?
Stock Price provides Insight into Intrinsic Value