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A Few Good Eggs: Markel Corporation (MKL), Staples (SPLS), and Heartland Express (HTLD)

February 25, 2009 | About:
Facing the music

When I was attending high school in the mid-1970s, disco was king, which heavily influenced fashion. Men’s suits had wide lapels and were worn with loud ties and shirts of every color under the sun. I can honestly say that I never was into fashion. Back then, my suits were either navy blue or gray, my ties were subdued, and I favored white shirts. I remember getting dressed to go to a friend’s wedding and as I headed out the door, my father commented that I dressed like a banker. I took that as a compliment.

While growing up, I wanted to work in the world of finance and thought that there could be no better occupation than being a banker. Bankers, in my mind, were held in high esteem by the community, dispensed sage advice, and acted and dressed in a conservative, subdued manner. As you can tell, I was quite naïve.

Over the past year the image that bankers had cultivated for decades has gone up in smoke, as they have gone from hero to zero in the public’s mind. Blame is being firmly placed on the shoulders of bankers whose actions have plunged our economy into the abyss. And to add insult to injury, they paid themselves handsomely for their actions.

Contempt for bankers had reached a fever pitch when Congress recently called on eight bankers to testify on Capitol Hill. They were attacked for their roles in the current financial crisis, lending practices, and perks. At one point, Congressman Michael Capuano (D-MA) told these financial titans: “America doesn’t trust you anymore … My hope is that you will be answering questions in court one day.”

While some anger is deserved, the CEOs of these eight banks haven’t really helped their causes. While some of their institutions were in trouble as the economic crisis became worse, they didn’t display the sensitivity that was expected from companies on the brink of bankruptcy. One of the banks that required government assistance had a $50 million private plane on order after receiving billions in government guarantees. Another CEO of an investment bank that needed to be acquired by another bank remodeled his office to the tune of $1.5 million, at shareholders’ expense.

During the time that their stock prices were plunging and their financial conditions were worsening, some of these CEOs continued to receive large salaries and even paid themselves and senior management bonuses! At the end of January, New York Attorney General Andrew Cuomo subpoenaed former Merrill Lynch CEO John Thain regarding $4 billion that had been paid in bonuses to Merrill Lynch executives in December 2007. It was not only the size of the bonuses that raised eyebrows but the timing. The allegation was that bonus approval was pushed through prior to Merrill Lynch reporting a $15 billion fourth quarter loss. Thain justified the bonuses by saying “even in troubled times you have to ‘pay’ to keep top talent.”

Financials Select Sector (SPDR)

Look at the performance chart of Financial Select Sector (SPDR). CEOs awarded themselves bonuses while stock prices plunged

That reminds me of the story overheard in a Las Vegas casino elevator. A wife was asking her husband for more money to play the slot machines as they headed toward the casino. The husband refused, telling the wife that she had already lost $100 the night before. The wife responded by saying to her husband “but you lost more than $50,000 at the blackjack table last night.” “Yeah,” said the husband, “but the difference is, I know how to gamble.”

Salary cap

After Wall Street lost more than $35 billion and triggered losses that number in the trillions of dollars around the world, executives gave themselves $18.4 billion in cash bonuses. The Obama administration put a $500,000 salary cap on executives of financial companies that have received or will receive federal aid. However, this will not solve the problem; it will only temporarily treat the symptom. The real problem is management teams that are not aligned with shareholders and do not feel that shareholders are the real owners.

If managers feel it is their divine right to command multimillion-dollar compensation packages for subpar performance – and their boards and shareholders agree – then more power to them. As a shareholder, I have the choice of becoming partners with more than 7,000 businesses on the American stock exchanges. The same way I wouldn’t want to be a silent partner in a partnership where my working partner drives a Bentley, has his own personal chef, and decorates his office with antiques – all with shareholder money – is the same way I wouldn’t want to be his partner in a public business by owning shares.

While it may seem that all managers of public companies are out to feather their own nests, it is not the case. The same way that not all politicians are dishonest is the same way that not all managers pillage their companies’ coffers.

A few good eggs

Here are three companies in different industries with managers who are aligned with shareholders. Their compensation packages put them in the same boat as shareholders, and as an owner that is exactly where you want them to be.

Markel Corporation (MKL)

Markel Corp. is a 79-year-old specialty insurance company that went public in 1986. The vice chairman, Steve Markel, is the founder’s grandson and incorporated its approach to shareholders from Warren Buffett’s Berkshire Hathaway.

The letter to shareholders starts off by addressing them as business partners. Executive compensation is based on performance and focuses on the long term. All executives get competitive salaries in addition to benefits packages. Bonuses are paid based on growth in book value over a five-year period, and substantial portions of the bonuses are paid out in restricted stock. There are no stock options awarded to management and all senior managers are expected to own shares. Many of them own many multiples of their salaries in Markel stock.

The company has in place a payroll deduction plan and offers low-interest loans to encourage stock ownership among its associates. As of the end of 2007, more than 10% of the outstanding shares were owned by associates. When Markel has a good year, everyone from top management to shareholders benefit. And it has had many good years since going public. Book value has increased more than 20.2% per annum over the 21-year period.

Staples (SPLS)

Executive compensation is broken down by base salary, performance-based cash bonuses, long-term equity incentives, and retirement benefits. Base salary is set at the middle range (50th percentile) of comparable positions in the company’s peer group. Bonuses are based on performance measured by sales (20%), earnings (30%), return on net assets (30%), and customer service levels (20%). The maximum bonus in any one year can’t be more than $4 million. The company’s 10-K report provides actual examples of how total compensation was determined for top management. There is nothing pushed under the rug here.

What is of interest is the requirement of each executive officer to have stock ownership based on a multiple of his or her salary. The CEO must own stock valued at 5x his salary, the CFO and COO at least 4x their salaries, and other officers ranging between 2x to 3x their salaries. Perhaps executive compensation has something to do with why Staples stands head and shoulders above its main competitors Office Depot and Office Max in the office supply sector.

Heartland Express (HTLD)

Heartland Express is a national truckload carrier that has management and shareholders directly aligned. Total compensation (salary, bonuses, stock awards, and all other compensation) for top executives in 2007 ranged from $163,000 to $311,000. What is unique about Heartland is the compensation to CEO Russell Gerdin, who receives only a base salary with no other bonuses. He hasn’t had a raise since 1986, and that’s at his request:

At Mr. Russell Gerdin’s request, his salary has remained the same since 1986 and he has never been paid a bonus … Mr. Russell Gerdin receives an incentive through appreciation in the market value of the Company’s stock. Because of Mr. Russell Gerdin’s request, the Compensation Committee did not consider or recommend an increase in annual compensation or any incentive compensation for Mr. Russell Gerdin. Thus, the Company’s performance directly affects Mr. Russell Gerdin, but not in the form of salary or bonuses (italics mine-editor).

Conclusion

I don’t think it’s the place of government to determine salaries for CEOs whose companies receive government assistance. Instead of focusing on salaries, why not require a CEO to invest the majority of his or her net worth in shares and hold them until the company pays back the government? A bonus could then be paid on a percentage of the total increase of the business’s value over a five-year period. I believe management that has more skin in the game will make decisions that are more prudent and focus on the long term.

It is not hard to find companies that have their shareholders’ interests at heart. The first place to look for them is in the companies’ proxy statements. It is there that compensation is clearly defined. If you can’t understand how a particular company’s compensation is paid out or if it goes against your better judgment, take a pass and don’t invest in that company. Keep in mind that when you are buying a share of a business you are really buying a piece of the company. If management appears to be taking the lion’s share for itself and leaving the shareholders with crumbs, don’t buy their shares – there are lots of other companies from which to choose.

Charles Mizrahi

hiddenvaluesalert.com

References:

1. Guerrera, Francesco, “Bankers Yield to Lawmakers’ Foreclosure Demands,” Financial Times, February 12, 2009.

2. Gasparino, Charlie, “Former Merrill CEO Thain Subpoenaed Over Bonuses,” January 27, 2009, www.cnbc.com/id/28874416

3. Zweig, Jason, “Pay Collars Won’t Hold Back Wall Street’s Big Dogs,” The Wall Street Journal, February 14, 2009.

4. Heartland Express 2008 Proxy Statement

About the author:

Charles Mizrahi
Charles Mizrahi is editor and publisher of Hidden Values Alert newsletter, which focuses on finding stocks trading significantly lower than their underlying business value. He has over 30 years experience in the financial world as a money manager and investor.

Visit Charles Mizrahi's Website


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