I remember the first time the thought hit me that Enron might be a sham, or at least a candidate to sell short -- it was the day the newswires picked up the story that Enron CEO Jeffrey Skilling had gotten rude and crude with a hedge fund manager during the company's conference call. What follows is a transcript of that short exchange, taken from the now-infamous Enron conference call of April 17, 2001.
Operator: Richard Grubman of Highfield Capital.
Grubman: Good morning. Can you tell us what the assets and liabilities from price risk management were at quarter-end, what those balances were?
Skilling: We do not have the balance sheet completed. We will have that done shortly when we file the Q. But until we put all of that together, we just cannot give you that.
Grubman: I'm trying to understand why that would appear to be an unreasonable request, in light of your comments about daily control of all your credits. I mean, you have a trading desk with a $21 million matched book that's two times your book value, and you cannot tell us what the balances are?
Skilling: I'm not saying we can't tell you what the balances are. We clearly have all of those positions on a daily basis, but at this point, we will wait to disclose those until all of the netting and the right accounting is put together.
Grubman: You're the only financial institution that cannot produce a balance sheet or cash flow statement with their earnings.
Skilling: Thank you very much, we appreciate that.
Grubman: We appreciate that.
Skilling: A%%-hole.
Prior to this call, I had only taken a fleeting look at Enron's stock, which was one of the hottest issues around. I was never tempted to buy, not because I had any inkling at all that it would become a stock market version of the Titanic, but because I couldn't understand the business. After this call, though, I remember thinking that something had to be seriously wrong to cause a company executive to totally lose it on a quarterly analyst call.
Of course, you all know how the story turned out -- Skilling was gone four months later and Enron became one of the biggest scandals in financial history. Richard Grubman's firm reportedly made as much as $50 million by shorting Enron stock before and after the call. More importantly, Mr. Grubman gave the financial community a real clue that something was amiss at Enron, a warning that most of the professionals assigned to the stock totally ignored until well after it was too late.
Conference call clues
The lesson here is simple: Conference calls offer a clue about how company executives communicate their message to their shareholders. Often, the lesson is that company executives don't have a clue. One learning experience for me that (thankfully) was not as expensive as it could have been was a company called Visible Genetics, where listening to the web-cast of the annual meeting prompted me to basically go out and sell my shares the next day.
I wrote about this experience briefly in a 2002 article entitled "The Cost of Bad Management." It was so bad that, after listening to the call late at night, I actually had nightmares about the stock. I remember waking up thinking "it's going to zero." Selling right then didn't save me from losing a little money, but it saved me from losing a lot.
By the way, you should know that there are some publicly traded companies that "manage" their conference calls as well as they manage their earnings. For some, this means that certain friendly analysts are given priority in the queue to ask their questions, bumping others down the list, often to the point where they never get to ask a question.
A money manager friend of mine once told me that he repeatedly followed the stated instructions for getting in the queue during one company's conference call only to hear from the operator that "there appear to be no further questions" and the call abruptly ended. I mention this so that you won't be overly thrilled if your favorite company's conference call turns into a love-fest. On the other hand, when a conference call turns nasty, it's usually worth paying attention to.
Cree's unwelcome caller
Just such an incident occurred the other day in a conference call from semiconductor material maker Cree
Operator: Thank you and the next question is from Cliff Josephie of H.D. Brown (ph).
Cliff Josephie: Thanks for taking my questions. I just wanted to make sure that...
Cynthia Merrell, Cree CFO: Excuse me. This is for the analysts to ask questions.
Cliff Josephie: OK. I'm with H.D. Browse, a brokerage firm. I can ask a question?
Cynthia Merrell: No, we have mentioned in our opening comments that we were restricting it to analysts only.
Cliff Josephie: Did any of the analysts ask about the $529,000 benefit you got on the contract if that helped you make the quarter by a penny...
Charles Swoboda, Cree CEO: Disconnect the caller. Disconnect.
Operator: There appear to be no further questions at this time.
The issue the caller is referring to here is a $529,000 "one-time adjustment" that, according to the company, was a "receipt of additional funding awarded on older contracts" received during the most recent quarter, while the "expenses associated with it were incurred in the prior quarter." With the benefit of this extra revenue, Cree was able to report earnings per share of $0.12, matching Wall Street's consensus estimate on the nose. Take away this extra revenue, and Cree misses by a penny.
I'll admit that while I've followed Cree with some interest over the past couple of years, it's not a company that I understand all that well. I've never taken a position on Cree either way. If you've been keeping up with it, you probably know all about the bizarre events that have transpired in the last year (check out this BusinessWeekarticle for some of the grisly details). Our own Rex Moore and Jeff Hwang have also been diligently following the soap opera (see the related links for recent stories). I know that both Rex and Jeff have had more or less favorable opinions about Cree.
My take on Cree is short and sweet: Be careful with this stock. I'm not all that worried about whether the $529,000 in revenue is legit or not, or whether the company would have missed earnings estimates without it. That's unimportant in the big picture, though troubling if true. My concern is this: Cree has a $1.25 billion market cap, which is 5.3 times annual sales and 32 times trailing reported earnings. There isn't any real free cash flow, since all the cash generated by the business is plowed back into capital expenditures. The current price is darned expensive for a stock with this kind of controversy.
Then there are the little warning signs: More than 30% of the total shares outstanding are sold short, and now this little conference call drama. I'm not worried about an Enron-type scenario with Cree, but there isn't a margin of safety within a mile of this stock. Stocks with this type of baggage usually come with a bargain price, but Cree investors are paying full fare and then some. Investing is a probability game, and I don't like the odds on this one.
Related articles on Cree
Guest columnist Zeke Ashton has been a long-time contributor to The Motley Fool and is the managing partner of Centaur Capital Partners LP, a money management firm based in Dallas, Texas. Please send your feedback to [email protected].
