Giving Up on Giving Guidance
Dan Warmenhoven saunters into a dining room at the Grand Hyatt Hotel in New York, with a broad smile on his face and hearty handshakes all around. And why not? It's analyst day for Warmenhoven and Network Appliance (NTAP), and the tech storage company has been on a tear. As NetApp's stock has gone from $15 a share to $38 over the past five years, Warmenhoven and his team have made loads of money for the company's largest shareholders, Fidelity Management & Research, AllianceBernstein (AB), and TCW Asset Management.
There's one issue that could disrupt the lovefest, however: guidance. Like many companies, NetApp gives financial analysts explicit guidance about what kind of financial performance it is expecting in the months ahead. Asked whether he would ever consider discontinuing the practice, Warmenhoven stares, grimaces, then laughs. He admits he has "mixed feelings" about guidance. "But if you stop, then investors are going to automatically think that there's something wrong," he says.
He's in an unusually complicated position. That's because his own boss, Don Valentine, the chairman of NetApp, has been prodding Warmenhoven to give up on guidance for years. "Look," says Warmenhoven, pulling out his BlackBerry and scrolling through his messages. "He just sent me an e-mail saying what kind of idiot would stand up in front of a roomful of people and predict something that they can't possibly know." When Warmenhoven reads part of the e-mail, it's worded much more diplomatically. But the point is essentially accurate—Warmenhoven and his chairman, two of the most respected executives in technology, are in open disagreement about the proper policy on guidance.
Many Pulling Back
It's a reflection of the intense debate going on inside U.S. companies these days. Supporters of corporate guidance, including major institutional shareholders, say that more information is better for investors and that a lack of regular guidance creates uncertainty. On the other side are critics like Valentine who argue that guidance, especially quarterly guidance, creates pressure to focus on the short term, opens companies up to litigation risk, and can be a distraction for management. "Issuing [quarterly] guidance is a fool's game," says Robert Pozen, chairman of MFS Investment Management in Boston and member of a U.S. Chamber of Commerce group that recently examined the issue.
Some companies are starting not to play. While the number of companies providing financial guidance increased sharply over the last 12 years, these numbers are now leveling off and appear to be pulling back. Since beverage giant Coca-Cola (KO) stopped giving quarterly and annual earnings guidance in 2003 (see BusinessWeek.com, 5/3/03, "Commentary: With Earnings Guidance, Silence Is Golden"), other big names have followed suit, including AT&T (T), Mattel (MAT), and McDonald's (MCD).
There has been a rush of companies joining them in recent weeks. On Apr. 26, Beazer Homes USA (BZH) and Pulte Homes (PHM), two homebuilders battered by the housing downturn, said they would provide no guidance for the rest of the year because the weak market made it too difficult to predict earnings (see BusinessWeek.com, 4/26/07, "Big Homebuilders Button Up"). On May 1, Blackstone Group, the private equity firm that plans to go public later this year, said it would not provide earnings guidance.
A Move to Annual Ranges
The movement could gain more momentum in the weeks ahead. Pozen and other members of a commission assembled by the U.S. Chamber of Commerce recently put out a study that argues the U.S. is in danger of losing its leadership in capital markets, in part because of guidance. The emphasis in the U.S. on quarterly projections and results, the group says, results in wasted time and effort, and is a distraction to the company and investors.
The chamber now is trying to create a groundswell among U.S. companies to stop issuing quarterly earnings goals, and instead provide annual ranges and more information about long-term goals. If they succeed, Pozen says, he hopes "markets believe this is a larger positive trend rather than masking a problem at a company." (See BusinessWeek.com, 4/2/07, "Goodbye Quarterly Targets?")
Google (GOOG) looks like a prime example. The search giant took a public stand against guidance when it went public back in 2004. "A management team distracted by a series of short-term targets is as pointless as a dieter stepping on a scale every half-hour," the company said at the time. Rather than hurt investors' trust, Google has made them huge amounts of money, as its stock has climbed from $85 at the initial public offering to $468 now.
Investors Like More Information
Guidance is a relatively new phenomenon. Only 92 companies gave guidance before Congress passed the Private Securities Litigation Reform Act of 1995 to give companies a safe harbor for disclosing forward-looking information, according to a McKinsey study. That number rose to 1,200 in 2001, and stayed fairly steady through 2004, the last year for which McKinsey has data. One academic study suggests that nearly 100 companies have dropped quarterly guidance in recent years, but definitive figures are not available.
Many investors say that additional information only helps them. Mike Thompson, managing director of research at Thomson Financial (TOC), is a major advocate. "If you want to have shock absorbers and a liquid market for your stock, then you want more information," he says. Jeffrey Kleintop, chief market strategist at LPL Financial Services in Boston, agrees. "Anything that restricts information flow increases volatility in stocks," he says. "To go backward [by getting rid of guidance] just doesn't make any sense in this day and age."
At NetApp, Warmenhoven and Valentine debate which way is forward all the time. Warmenhoven, 55, is a well-respected chief executive and one of the longest-tenured CEOs in the tech industry, having taken over the post in 1994. Valentine, 74, is something of a legend in Silicon Valley. He founded the venture capital firm Sequoia Capital and has backed a long list of tech stalwarts, including Cisco Systems (CSCO), Apple (AAPL), Oracle (ORCL), and Electronic Arts (ERTS). The press-shy Valentine declined to comment for this story, but his views were described by Warmenhoven (see BusinessWeek.com, 12/27/05, "NetApp's Affable Aggressor").
Experience With Litigation
Their differing views of guidance are colored to a surprising degree by litigation risks. Valentine thinks that providing investors with a specific target for a quarter or a year could open up the company to lawsuits. The theory is that if NetApp misses the projection, then securities lawyers could sue the company for misleading investors. "He wonders, 'What's to be gained from this?'" says Warmenhoven.
Warmenhoven is wary of litigation, too. Prior to joining NetApp, he was chief executive of Network Equipment Technologies (NWK), where he had to wrestle with a shareholder class action for two years. It's an experience he never wants to go through again. He thinks that providing guidance gives you more control over the expectations of shareholders and Wall Street analysts. In March, he tempered analysts' forecasts for earnings for the current year, dropping the storage company's share price about 3%. "Even if you don't give guidance, the sell side analysts will generate a Street estimate," he says, and that sometimes gets ahead of the stock and ahead of expectations.
NetApp started giving guidance when it went public in 1995 on its first quarterly earnings call with analysts. Warmenhoven said that most companies were doing so at the time, in the wake of the Litigation Reform Act. "It seemed very natural at the time, so it was never a conscious decision," he says.
But now Warmenhoven recognizes that times have changed. What was once a "low-risk practice" has now become high-risk, because of what he calls "ambulance chasing" securities lawyers who target companies that experience a big drop in their stock price. But he struggles with the decision.
"It's a little harder for a company like us, trading for 12 years, to stop," he says. He also wants to do right by his shareholders and many of them want him to continue providing his best estimates of the future. Meanwhile, the top two executives at NetApp continue to debate the proper course of action and whether it's time to end financial guidance once and for all. "It's a bit of a dicey game—you're damned if you do and damned if you don't."