Clearwater Paper (NYSE: CLW) pops up on many of my screens lately. By several surface-level indicators, it looks cheap. Its P/E ratio is a meager 3.9. Its enterprise-value-to-EBITDA ratio is just 1.7. And at its current $55 price tag, it's trading at only 1.7 times the company's tangible book value.
Unfortunately, its management seriously makes me very nervous.
A matter of scale
The first red flag to me here is that the whole management team, taken together, owns just 1% of Clearwater's shares. That figure alone isn't enough to send me running for the hills. After all, the savvy managers at Costco Wholesale (Nasdaq: COST) own just 1% of the company they run each day. The difference is that Costco is huge. A single percent of Costco means that CEO Jim Sinegal and his team are sitting on $244 million in Costco stock. With that kind of cash at stake, I'm comfortable that management's motivations are the same as my own.
Clearwater, on the other hand, is a small company. It has a market cap of just $634 million. A lone percentage point of insider ownership amounts to less than $6.5 million of management's personal money invested alongside that of shareholders.
Even managers of Clearwater's smaller competitor Wausau Paper (NYSE: WPP) have a higher monetary stake in that company. With a market cap of only $385 million, Wausau is just more than half the size of Clearwater, yet its management team owns more than $30 million worth of stock -- more than quadruple that of Clearwater's managers.
Taken together, I am simply not confident that Clearwater executives have the same incentives as shareholders.
What are their incentives?
This question led me to dig through Clearwater's executive compensation, which the company frames as an effort to pay its managers for great performance -- a good thing for shareholders. But from what I can tell, Clearwater's executive-pay policies seem to aim instead to make those executives rich.
Most of Clearwater's executives' pay comes as "incentive compensation," which ties the amount of pay to how well executives perform in terms of a given metric. The metric to which cash bonuses were tied last year was EBITDA. So far, I like this: Management has incentives to grow EBITDA, a meaningful measure, and is compensated based on how well it does. But the devil is in the details.
Last year, if Clearwater hit its target of $72 million in EBITDA, CEO Gordon Jones would have received a bonus of $910,000. If EBITDA exceeded that target, the CEO's salary would have grown dramatically. EBITDA did exceed that target, clocking in at $174 million, which translated into a $1.5 million bonus for Jones. But that bonus was based on an artificially low target of $72 million -- well below Clearwater's average EBITDA of $90 million over the past three years.
I'm not arguing that the CEO didn't produce improved results last year. And I'm not arguing against paying executives for great performance. But I'm certainly uncomfortable putting my money in the hands of managers who seem more intent on directing profits into their own pockets than sharing them with me.
