Comments from the Fools,
CalPERS vs. AMD
fnews.yahoo.com
Shareowners of chipmaker Advanced Micro Devices (NYSE: AMD) will have a ringside seat tomorrow at a corporate governance brumping contest. In one corner, AMD's longtime chairperson and CEO Jerry Sanders. In the other corner, the California Public Employees' Retirement System (CalPERS), the heavyweight of public pension funds, with more than $140 billion in assets, including 504,000 shares of Advanced Micro.
In February, CalPERS put AMD on its top ten list of corporate wealth-destroyers. Tomorrow, the pension plan hopes to take an important step toward turning around the company's years of underperformance by bouncing Sanders from one of his jobs. Institutional Shareholder Services (ISS), an outside advisory group started by legendary shareholder rights activist Robert A.G. Monks, is backing the proposal. Shareowners will judge the bout by way of a proxy vote.
The core issue is the connection between corporate governance practices and a company's business and stock performance. When investors buy stock in a company, they're taking an ownership position that entitles them to a cut of the firm's future profits. Management is there to run the business in a way that generates such profits. The board of directors is there to represent shareowner interests, to ensure, in other words, that management is doing a good job of creating wealth for the owners and doing so in an ethical fashion. Directors are accountable because they are elected by shareowners, preferably on an annual basis. Management is accountable to the board because the CEO basically serves at the board's will.
Governance rules work best when they insure that management is responsive to the board, which is responsive to shareholders. While good governance doesn't necessarily make for a successful business, bad governance often perpetuates an unsuccessful one, to the detriment of its owners. The CalPERS proposal indicts AMD's current practice of combining the position of CEO and board chairperson in one person. It implies that the company's poor performance owes something to bad governance practices that make it difficult for the board to monitor and, if necessary, replace management.
"When the Board's Chairperson is also an officer, employee or otherwise closely related to the Company's management, it is difficult for that person to objectively perform this monitoring and evaluation function," said CalPERS CEO James E. Burton in a letter to AMD's shareowners. "We believe that an independent chairperson would best ensure that the interests of shareowners are served, rather than the interests of management. Our proposal asks that the Board's leader be a person who is independent of the Company and its officers."
Over the past decade or so, CalPERS has led the way in a form of investor activism that ties governance issues with performance. Because of its size, the pension plan is basically forced to invest in a wide assortment of public companies. As obligatory buy-and-hold investors, then, the fund has come to realize it has a fiduciary obligation to focus on market laggards. Each year it singles out ten companies for special attention, which includes everything from jawboning management and directors to launching full-fledged proxy battles if talks prove unproductive. The laggards list is compiled based on the firms' stock performance, corporate governance practices, and, now, an economic value-added (EVA) analysis. EVA considers a firm's after-tax net operating profits after subtracting the cost of capital required to generate that return. In other words, EVA provides a means of determining whether a company is really generating a meaningful return above the foregone opportunity of investing that capital elsewhere.
CalPERS charges that between 1993 and 1996, Advanced Micro destroyed 22% of its shareowners' capital based on EVA analysis. Looking at the stock's performance, $100 invested in AMD at the end of 1992 would have been worth just $98 at the end of last year. The same $100 would have grown to $369 if invested in the Technology 500 index, a peer group, or $251 if invested in the S&P 500. Even considering that AMD shares have rebounded sharply this year, from $17 7/8 to $27 9/16, the stock has still been a laggard by comparison.
AMD has invested heavily to produce clones of Intel's (Nasdaq: INTC) microprocessors, the brains of most personal computers. Recently, a Standard and Poor's report indicated that AMD has had negative cash flow of $700 million over the last four years, but it still plans to spend about $900 million this year on new facilities. That report also downgraded the company's debt to single B from double B minus, well into "junk" status. Despite such huge investments, AMD has thus far failed to gain a meaningful share of the central processing unit (CPU) market, due partially to production problems that have left it with relatively weak sales and a $21 million loss in 1997 after a $69 million loss in 1996.
The company did manage to boost production of its popular K6 chips in the September quarter to one million units from just 350,000 units in the June quarter. Yet that was substantially below the target of 1.2 to 1.5 million units and resulted in a loss of $32 million in the quarter. Some analysts suggested that AMD's production yields were running around 20%, meaning that for every five chips the firm produced, only one was good enough to sell. Similarly, AMD had hoped to produce two million K6 chips in the December quarter, but since yields improved to just 45%, the company shipped only 1.5 million units during the fourth quarter, leading to another loss of $12 million.
Advanced Micro has reported some better news of late. January saw the release of new low-priced Compaq (NYSE: CPQ) Presarios and IBM (NYSE: IBM) Aptivas featuring the K6 microprocessor. IBM has also announced it would help AMD boost its production to about 15 million units this year. Despite a March quarter loss of $56 million, Advanced Micro said it has resolved the yield problems on its 0.35 micron production lines and expects to have completed the transition to more profitable 0.25 micron production lines for its higher-performance 300-megahertz K6 processors by June. The company is also working to raise $400 million in a public offering of convertible notes.
While the market has rewarded the stock for these developments, the company must begin to execute better if it hopes to have a chance of competing against the incredibly well-capitalized Intel, which recently introduced its Celeron line of CPUs for the under $1,000 box market. AMD has said it hopes to undercut Intel's prices by 25%, but without better production yields, that's a strategy doomed to create massive losses.
Although CalPERS probably won't win this proxy battle, it almost always wins the war. Wilshire Associates studied 62 firms targeted by the pension fund over a five-year period, finding that their stocks underperformed the S&P 500 by 85% in the five years before CalPERS stepped in but outperformed the index by 54% in the five years after the fund took action. Last year, for example, CalPERS voted against Apple's (Nasdaq: AAPL) board of directors, arguing that the board was weak and that top management lacked computer industry experience. Both problems have now been resolved, and the stock has soared as a result. Of course, CalPERS couldn't be happy with Steve Jobs combining the chair and CEO positions or with the lack of stock ownership by board members.
Such governance issues can and often do matter in the long term. But even in cases where CalPERS' specific governance goals aren't addressed, the fund often succeeds in the more basic task of giving a company's management and board a solid kick in the butt. Not only is that constructive, but it's also fun to watch. |
