Shareholders of Hain Celestial (NASDAQ:HAIN) have endured a stomach-churning year. In August, the company announced that it would have to delay filing its quarterly report, saying: "The Company is currently evaluating whether the revenue associated with [Concessions that were granted to certain distributors] was accounted for in the correct period."
A few months later, the company announced it "found no evidence of intentional wrongdoing," in connection with the accounting snafu. Sounds benign enough, right? Yet investors still haven't seen a quarterly report, as the scope of the company's investigation has widened, and the SEC has opened a formal investigation on Hain.
Most of the headlines involving Hain these days have centered on these accounting troubles, but with so much attention there, many have overlooked the fact that at its core, Hain's strategy, paired with incentives and leadership compensation, wasn't building a business designed for long term investors.
How much skin in the game for management?
No one knows more about what's going on at Hain than founder and CEO Irwin Simon. So I went back to look at his ownership of the business to see how much skin Irwin has in the game.
What I found was disappointing.
It's hard to miss the trends at play here.
The red line represents Simon's stake in the business -- the type of skin in the game that I as a shareholder want to see.
The green line largely represents only upside for Simon; while some of that compensation comes via equity rewards, many of those shares are sold, and still more is provided by cash bonuses for meeting certain criteria.
This graph doesn't go back all the way for the company. I started in 2003 because that's when Simon's total stock ownership peaked at a split-adjusted 6.13 million shares. Simon has shed about 59% of those shares since then. In that time, Hain's shares outstanding has increased from roughly 70 million to over 100 million, further diluting Simon's stake in the business.
But his compensation package has gone in the opposite direction: from $2.8 million per year during the first three years of the range to $18.2 million over the three most recently reported years. That's a jump of 550%. As a result, he has much less alignment with shareholders in the company's long-term success than he once did.
How is Simon incentivized?
Simon has had several different compensation packages determined by meeting pre-set goals. The earlier agreements don't specify exact criteria, while the later ones -- thanks to demands for transparency in the Age of the Internet -- are much easier to parse out.
At its core, Simon was compensated for continually meeting (often year-over-year) growth goals for:
- Overall revenue
- Overall earnings per share
- Adjusted EBITDA
On the face of it, there's nothing wrong with these metrics. In fact, they're pretty solid. There's one problem, though: They are awful guidelines for a company like Hain Celestial.
That's because Hain has become a leader in natural/organic foods and personal care products by becoming a serial acquirer.
The company has rolled up hundreds of smaller brand names that have made a name for themselves independently. By acquiring them, the thinking goes, Hain can inject the money and scale necessary to take them to the next level.
Except, that may not be what's happening at all. One 2015 review on Glassdoor.com stated: "Hain's current acquisition model essentially operates on limiting up-front costs ... they slim down an acquired brand's team to the bare minimum."
Similar reviews paint an equally unflattering picture.
This opens up the door for an alarming possibility: Hain could have been continually buying up smaller players because management knew it would have an immediately positive impact on revenue. Then, by cutting the acquired brand's operations down to the bare bones, it could eek out greater profitability.
While a great strategy for the short term, this could be disastrous for shareholders over the long run.
The information investors want...but don't get
Of course, one review from an anonymous employee should never inform an investing decision. There's got to be cold, hard, numbers in there, too. I would argue that organic revenue growth -- how much Hain was able to grow the brands it's already owned for a year -- would be a much better indicator for whether or not Hain is actually any good as a business.
Just don't tell that to management.
In 2008, a rather shocking confrontation happened during the company's conference call when analyst Daniel Khoshaba of KSA tried to get this critical number from Ira Lamel, Hain's CFO at the time. According to Seeking Alpha, here's how it went down:
Ira Lamel: "There is no way I am going to be able to give you what our organic growth at retail was on Celestial."
Daniel Khoshaba: "You don't have organic, well, how about organic growth for the company?"
Lamel: "We do not give organic growth for the company."
Khoshaba: "Why not?"
Lamel: "Because we don't give it."
Khoshaba: "I would think you would want to share it that with your shareholders?"
Lamel: "We don't give it. Can we move on to the next question?"
This sequence alone should be enough to give investors pause. Management is purposely obscuring a key metric.
I say "purposely" because in future conference calls, several analysts -- especially Greg Badishkanian of Citigroup (NYSE:C) -- tried to figure out what the organic growth rates are by doing some backwards math.
For a period, Badishkanian offered up estimates based on his models and asked Hain's management how far off they were. Management would then generally tell him his figure was in the ballpark -- in the Q1 2009 call, Lamel told Badishkanian "I think you figured it out pretty closely."
The fact of the matter is that management knew very well what the number was. If they didn't, they wouldn't know if an analyst's guess was correct.
By the time 2013 rolled around, management had changed its tune. John Carroll, CEO of Hain Celestial's U.S. operations, had this to say at an investor conference, according to a Seeking Alpha transcript (emphasis added):
We will be able to ... focus on the brands that we've acquired and drive them organically because organic growth is the underpinning of the company.
But even then, the company wasn't completely forthcoming. On the very next conference call, the most Simon would say about organic growth was that "it was around high single digits."
What does that mean?
Sure, "high single-digits" could be -- say -- 7% to 9%. But "around" that number? Do we go as low as 5%? Maybe 4%? Is this really a good way to report on what your executive claimed three months earlier to be "the underpinning of the company"?
The cat-and-mouse game continued -- at varying levels -- over the coming years. At times, very specific numbers were given. At others, they weren't.
But starting in November 2015, the results were getting ugly in the United States, the market responsible for about 40% of the company's business:
- November 2015: Simon said, "U.S. organic growth from the U.S. businesses were down."
- February 2016: Simon said (emphasis added), "Organic growth for all our businesses, excluding the U.S., was up high single-digits."
- May 2016: CFO Pasquale Conte said: "Our UK business delivered low-single-digit organic growth." No specifics were given for U.S. organic growth.
Combine this with slowdowns at some of Hain's biggest customers -- Whole Foods and United Natural Foods -- and it shouldn't be too surprising that growth started slowing.
The signal and the noise...
The accounting scandal itself shouldn't be too scary, it's the underlying factors that may have led to it that are concerning.
We've already seen from the fate of Whole Foods that the moat that a brand provides in the natural/organic food space is sparse. What shoppers really care about is that a product is labeled "organic." After that, they'll go for the cheapest option available -- which often means private label brands.
Add to that the fact that it appears Hain's management was incentivized to squeeze out short-term profit from its brands while possibly not investing the requisite amount in their long-term success, and you may a recipe for commoditization.
Hain may emerge from this crisis unscathed. In fact, given the recent spat of M&A rumors, I wouldn't be surprised to see its name mentioned as a potential buyout candidate. But at the end of the day, you have a company operating in an industry that has narrower moats than once thought, and you have a management team that may have been destroying whatever moats existed in the first place...all while being incentivized to do so.