What To Expect When Your CFO Leaves You
- Tesla's CFO has retired. Investors tend to view that type of turnover as a red flag, so I looked for evidence as to why that might be the case.
- The Fed is turning dovish, while the market seems to have taken Friday's jobs report in stride. I'm learning some lessons about market timing.
- Our editors had a lot of strong recommendations, ranging from a niche piece on some misunderstood warrants to an exploration of what bond market bears have gotten wrong.
Happy Trails To Tesla CFO Deepak Ahuja
It's common for bears and short-sellers to point to a CFO departure as a strong negative for a company and its stock.
A similar reaction emerged after Tesla's earnings call Wednesday when Elon Musk announced the departure of CFO Deepak Ahuja. It's Ahuja's second retirement from the company, and by all appearances they expect this one to stick. Ahuja's internal replacement, Zachary Kirkhorn, has been at Tesla almost a decade and is in his mid-30s.
Commentators on Twitter are making a big deal out of this. Intuitively, it makes sense: A departure by your head accountant is probably disruptive and it's hard to imagine that it's ever a good thing. In the worst case situation, the CFO might be leaving due to major problems in a company's reporting. But those are just gut-feelings on my part. To find out what types of trends are associated with CFO departures, I looked at some abstracts from the academic literature. At a glance, the findings don't look good.
Here's the abstract for Shehzad Mian's "On The Choice And Replacement Of Chief Financial Officers," published in April 2001 and cited 96 times:
Key findings reported in the paper are: (A) external CFO succession rate is markedly higher than the external CEO succession rate, (B) the incidence of retirement is less common for serving CFOs as compared to the top executive, (C) CFO turnover is preceded by negative excess returns, (D) CFO turnover is preceded by a decline in operating return on assets in the pre-period, (E) announcements of CFO turnover are associated with a significant negative stock price reaction when old CFO quits and firm replaces with an internal appointment, and (F) CFO turnover is preceded by abnormally high CEO turnover.
Tesla shareholders might be concerned about items (C), (D), (E), and (F). The stock market does not like CFO turnover and it does not like internal replacements. Both of those are relevant in Tesla's case. The bit about operating results declining is also concerning.
Another paper, "Does Hiring a New CFO Change Things? An Investigation of Changes in Discretionary Accruals," says that financial reporting changes as the result of a new CFO.
We find that discretionary accruals decreased significantly following the appointment of a new CFO. Our tests indicate that this reduction is significantly greater for our group of CFO‐hiring firms than for a control group of non‐hiring firms, and that the changes are not driven by a concurrent appointment of a new Chief Executive Officer (CEO). We also find that our results are largely driven by firms that hire a new CFO from outside the company. Our study extends earlier research by providing empirical evidence that individuals in CFO positions wield significant influence over the firm's reported financial results and that a firm's discretionary accruals are significantly reduced surrounding the appointment of a new CFO.
To the extent that companies have control over how they recognize their accrued operating activities (revenues and expenses), a new CFO tends to be more conservative in logging these activities.
Are these findings predictive of Tesla's future? I don't know - I'm sure sometimes CFOs retire because they're ready to do so, and I don't have a basis to conjecture one way or the other on this particular instance. But if you're just looking at what tends to happen in these situations, it's hard to figure this as a positive for any company. Then again, Elon Musk and Tesla have defied a lot of investors' expectations for a very long time.
SA contributor Donn Bailey says the CFO announcement is one of several items from the call that should give long investors pause.
So, now, Tesla has a new Chairperson of the Board with zero automotive experience and a new Chief Financial Officer with no public accounting experience. Musk is back in total control of Tesla in less than two months with no one to stand up to him. It seems Musk has been able to sidestep any controls the SEC had hoped to use to rein in Musk's questionable activities.
(Correction 2/8/2019: As you can see in the comments, I originally wrongly attributed this quote to Bill Cunningham. I regret the mistake.)
Of course, Tesla is never as simple as one event or one key retirement. The SA community is all over the rest of the story as well. Numbers Nerd praises the company's emphasis on raising cash and reducing dependence on capital markets: "The growth story has been temporarily put on hold in return for removal of bankruptcy risk." Bram de Haas likewise sees some positive elements in the most recent earnings report but highlights a potential decline in 2019 growth.
Anton Wahlman, a longtime Tesla critic, highlights what he sees as questionable claims made by management on the conference call, keying in on technological innovations.
Also, check out:
FOMC And Jobs
I have a long position in the ProShares Short QQQ ETF (PSQ), which I view as more of a market hedge than an outright bearish call. I entered the position after the Nasdaq 100 dropped below its 200-day moving average. Since my strategy is effectively trend following, I've been more focused lately on daily price moves in the index than is probably healthy or advisable.
As a general rule, I also try not to focus too intently on the Fed's actions, but it was hard not to anecdotally tie this week's rise in the S&P 500 (and the Nasdaq) to the Fed meeting and related announcements this week. The recent shift from a hawkish to more dovish posture has surprised me somewhat, given what has looked like the continual flow of positive macroeconomic data. Russell Investments did a nice job of analyzing the market reaction to the Fed:
The January statement removed the reference to further gradual increases, scrapped the central bank's assessment that risks to the economic outlook are roughly balanced (hinting that they are skewing slightly to the downside now), and noted that inflationary pressures are muted. Translation: the Fed is on hold until at least June. The battery of dovish tweaks to the Fed's guidance was enough to lift U.S. equities in the minutes following the announcement.
My favorite thing about the Fed is that its critics will sling mud at it no matter what choices it makes. Some (like the creator of this cartoon) believe that this latest position is a capitulation to pressure from the markets. The irony is that a rate hike would probably have invited criticism that the Fed is out of touch and failing to take recession risk seriously.
Meanwhile, Friday's jobs report was more or less a blowout. There was no shortage of amazement in the Seeking Alpha offices at the 304,000 jobs added. The economy is on a long streak of adding jobs. Marc Chandler has a good quick synopsis. He views the report as mixed and limited in its effect not just on the Fed but also on the stock market.
It was a tough week to be a bear or even just lightly hedged, as I am. My PSQ position is teaching me the obvious lesson that timing the market is hard, and that trying to do so makes me obsess over factors I do not control. It's a more exciting way to live, but so far, it has not been super profitable.
Read These Articles
SA Editor John Leonard recommends this long idea on JD.com (JD) because it's a "compelling SOTP/contrarian case." My colleague and Behind The Idea co-host Daniel Shvartsman also agrees. We selected this article for next week's podcast. There's a lot to untangle: opacity around Chinese companies in general; a rape accusation against the CEO (charges were not pursued); a seemingly very cheap valuation.
Also from John: "NRC Group Warrants: Too Cheap By A Wide Margin." (NRCG) John sees multiple catalysts for this underfollowed SPAC.
Gil Weinreich suggests "Will The 35th Recession Bring A Swift Return To Zero Percent Interest Rates?" and "Rush Hour And Short Cuts: How To Navigate Market Corrections."
SA Editor Jason Kirsch also recommends "The Bond Bear Market That Never Came," (TLT) for its contrarian approach.
Finally, we have "You Are Going To Have Too Much Money," suggested by SA Editor Radhakrishnan Raman.
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Analyst’s Disclosure: I am/we are long PSQ.
I am long ERUS, EWZ, JNK, PSQ, and TUR.
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