Decaffeinating Green Mountain

Last October, David Einhorn, head of Greenlight Capital, a hedge fund famous for taking short positions in Lehman Brothers’ shares before Lehman failed, attacked Green Mountain Coffee Roasters’ in a presentation at an investors’ conference. It was a tour-de-force of financial analysis. Using only publicly available information, Einhorn made a strong case for unrealistic sales growth and overstated earnings. Since then, things have only gotten worse for Green Mountain. The share price collapsed. Robert Stiller, the founder, was forced to sell shares to meet margin calls on $617 million in personal debt secured by his Green Mountain shares and had to resign the company’s chairmanship. The SEC continued with an investigation into the lack of disclosures about a key distributor. And many of David Einhorn’s concerns remain. We’ve looked at one of the issues he raised: capitalizing operating costs. Here’s our own analysis, updated with the latest fiscal year data. As Green Mountain reports it, sales have been growing at an striking rate, propelled by demand for its K-Cup coffee brewers and pods and by acquisitions. After a dip in 2010, Green Mountain’s EBITDA margins expanded along with sales, peaking at nearly 18% in the fiscal year ending in September 2011. One tactic companies use to understate expenses is to capitalize them. That is, they add current period operating costs to property, plant, and equipment — or some other asset with a life of more than a year — instead of treating them as cost of goods sold or selling, general, and administrative expenses. That spreads them out over a number of reporting periods as part of depreciation expense...

There’s Your Sign

At a lunch meeting in July 2011 to go over his concerns about massive, unexplained fees linked to Olympus’ acquisition of Gyrus in 2008, Michael Woodford, the new President and CEO, got the first sign his job was in danger. Chairman Tsuyoshi Kikukawa and Group President Hisashi Mori were served an elegant assortment of sushi; Woodford got a tuna sandwich. In October, Woodford was fired before he could press his inquiry any further. Since then, Olympus has been forced to take a $1.3 billion loss and see its credit rating fall two notches to BBB+. Kikukawa and Mori have lost their jobs and been arrested. The tuna sandwich was Woodford’s own early warning, but how could an outside analyst have seen Olympus’ problems developing? We’ve blogged about the early warning signs of companies in distress before: Early Warning Signs at Borders Part 1 and Part 2. We think Olympus is a good example of our sixth sign, problems with management. Olympus is a classic example of a recurring problem with management at troubled companies: desperate strategies. From 2008 on, as smart phones with built-in cameras grew in popularity, the company’s sales of digital cameras suffered and profits collapsed. And digital cameras were vitally important to Olympus, accounting for as much as 26% of sales but only 8% of operating profits in 2008. What was management’s response? Unable to counter the threat from telephone cameras, Olympus made a string of senseless acquisitions, including companies in pet care, medical-waste disposal, microwave cookware, and mail order cosmetics. When it made an acquisition in a core business, Gyrus in medical equipment, it overpaid....

Early Warning Signs at Borders Part 2

It may be disappointing, but it can’t be surprising that Borders Group went bankrupt this week. It was clear some time ago the company was heading deep into distress. What made it so clear? The six classic early warning signs of financial distress. We covered the first three in our last blog post. Here’s a brief video about the last three. [youtube...

Early Warning Signs at Borders Part 1

We blogged about Borders Group back on January 4. Even though the company has a new financing commitment, it continues to have problems paying suppliers. It looks like Borders is still circling the drain. Borders’ survival is questionable, but for us the more interesting question is, “How could we have have seen the trouble at Borders coming?” What were the warning signs of Borders’ distress? In this video post we talk about three of the six early warning signs of financial distress and see how they apply to Borders. We’ll talk about the other three in our next post. [youtube SXjauKH5s7c] Early Warning Signs Part...

Master of the world?

Jean Marie Messier became Chairman of Compagnie General des Eaux in 1996 at the age of 38. He was a graduate of elite French universities. At age 29, he held a senior post in the French Ministry of Economy and Finance. At age 32, he joined Lazard Frères, where he became the French investment bank’s youngest general partner. He renamed the company Vivendi in 1999. And under Messier, Vivendi’s deal flow was staggering: the company sold 39 businesses and bought control of or stakes in 65 others. The capstone deal was a merger with Seagram-Universal and Canal Plus in 2000. The share price climbed to a record high, and Messier became a darling of the financial press. Time magazine named Messier the 12th most influential businessperson in the world, and the French Government awarded him the Legion of Honor. Articles in Business Week and Fortune compared him to Jack Welch, the legendary CEO of General Electric. The French press called him Jean “Magic” Messier. But Messier preferred J6M, which stood for Jean Marie Messier, moi-meme maitre du monde (“Jean Marie Messier, myself, master of the world”). Massive impairment charges hurt the company’s credit ratings in 2001, which led to problems rolling over short-term debt, which put pressure on liquidity, which hurt the share price. Messier fought back in 2002 with a massive increase in share buybacks, a special dividend, and a request for a big increase in his compensation. Directors began resigning in packs, and Messier lost his job that July. He paid over $2 million in civil fines for misleading investors in France and the United States. Now...