Telecom equipment providers Infinera (INFN 1.84%), Ciena (CIEN 0.72%), and Cisco Systems (CSCO 0.06%) are competing fiercely to capture market share as their customers launch the next major equipment-upgrade cycle of the telecom and Internet backbone. Without leadership that seeks long-term benefits for the shareholders, however, little if any of the value they create will trickle down to the shareholders.
To achieve long-term market-beating returns, management incentives aligned with that goal must be employed by a company's board of directors. This is an art Warren Buffett has mastered to the great reward of his own shareholders. Three key ingredients to cultivating long-term stewardship include:
- Insider ownership, which is the amount and percent of the company's stock the leaders own
- The nature of their compensation
- The objectives they must achieve to receive that compensation. Cisco, Ciena, and Infinera differ markedly in these ingredients, with repercussions to their respective futures.
Inside ownership
Leaders with real skin in the game -- ones that have significant equity ownership in their company -- have their financial fate tied closely to the company. I'm satisfied if the CEO has enough at stake for total financial freedom, say at least $5 million, and if the leadership team including all the executive officers and board members collectively holds at least 5% of the company.
All three CEOs pass the equity test, with a tip of the hat to Cisco's CEO at $175 million, as well as to Infinera's CEO at $18 million. These are motivating investments in their respective companies. Only Infinera's leadership team, however, passes the percentage ownership test. Cisco's team perhaps can be excused for its large market cap and age, but not so for smaller, younger Ciena.
CEO & Leader Ownership
|
| INFN |
CIEN |
CSCO |
|---|---|---|---|
|
CEO equity (millions) |
$18 |
$6 |
$175 |
|
Leader ownership |
5.2% |
2% |
0.4% |
|
Market cap (billions) |
$1 |
$2 |
$120 |
|
Company age |
14 years |
20 years |
30 years |
Source: Each company's latest DEF 14A
Compensation and objectives
Compensation typically is provided through salary and restricted stock units, or RSUs, both of which are guaranteed pay, and cash bonuses and performance stock units , or PSUs. Both of these are tied to the incentives established by the board. All three companies tie most of their leadership pay to performance, especially Cisco's CEO at 95% -- and it is tied to performance over the next three to four years, encouraging long-term stewardship.
Infinera and Cisco have explicit performance incentives that motivate both growth of the company and increases in share price. Infinera takes the unusual step of incentivizing a minimum cash and investments balance to preclude blowing all of its "rainy day fund" on an acquisition spree. This appears to be encouraging the company to win business organically rather than merely buying it, and to avoid the crippling bind Ciena found itself in during the dot-com meltdown more than a decade ago. Cisco, in contrast, is at liberty to continue its tradition of acquisitions as long as they are accretive, though I dislike their "board discretion" criterion, which opens the door to rewarding poor performance.
Ciena's incentives, in stark contrast, are micro-managing operational criteria that motivate activity and efficiency, but not the per-share growth shareholders require to prosper. Worse, its incentives read like the chairman, the former CEO of many years, is telling the current CEO how to run the company instead of defining the corporate objectives and allowing the current CEO to decide how best to achieve them.
Compensation & Incentives
|
|
INFN |
CIEN |
CSCO |
|---|---|---|---|
|
Pay tied to Performance |
59% |
52% |
95% |
|
Performance timescale |
3 years |
3 years |
4 years |
|
Financial criteria |
Revenue, operating income, cash and investment balance, share price vs. index |
Operating income |
Revenue, operating income and cash flow, earnings per share, share price vs. index |
|
Operational criteria |
3 Strategic customer wins, cash balance. |
2 key product releases, sales quotas in 3 product areas, product cost reduction, cash cycle, personnel performance plans |
Customer satisfaction, board discretion. |
Source: Each company's latest DEF 14A
Final takeaway
There is convergence of the three leadership teams toward long-term stewardship through significant equity ownership and the attachment of most of their compensation to multi-year performance metrics. From this sound footing, they quickly diverge.
Infinera is focused on organic growth and increasing market share through capturing new strategic customers. Cisco is incentivized to grow by any means as long as it is accretive to the company's per-share metrics. Ciena, in contrast, appears lost in the operational forest, with neither strategic, nor shareholder-friendly incentives to guide it.
This divergence of incentives bodes well for Infinera on two counts: Ciena is the more direct competitor, but lacks effective strategic incentives. Cisco is willing to yield business in a particular market, perhaps even Infinera's market if they do well enough, if Cisco can gain more elsewhere. Cisco's recent sale of Linksys is an example of such yielding.
Given Infinera's small size, a significant market penetration from any combination of superior performance on its part, tactically focused performance from Ciena, or yielding by Cisco, would result in exceptional long-term share appreciation. Infinera's leadership incentive structure, therefore, appears the best-poised of the three companies to promote superior shareholder return.
