In my last column I assessed some of the damage that a closed corporate mind can have on a company’s future. The example I used was General Motors, and the corporate heads there who refused to entertain both the potential impact of falling energy prices on GM’s business plans and the potential for a big-car American consumer who would benefit from low gasoline prices. Let’s visit the 1980’s time-period once again with another illustration of how closed-minded management can fail a company.
Companies must be willing to accept the possibility that an alternative economic environment in the future can void the best laid plans for success. The executive shortcoming I’ll analyze here is arrogance. Rowan Companies, the provider of oil-well drilling services, shows us just how damaging arrogance can be — to a company and its investors alike.
The energy study produced by Laffer Associates that I mentioned in my last article was distributed to Laffer clients back in 1981. One of the firm’s clients was a portfolio manager in Texas who forwarded a copy of the report to one of his clients, a key executive at Rowan Companies. Obviously, the outlook for Rowan’s business would diminish if the Laffer forecast for substantially lower oil prices came to pass.
The Rowan executive did not take Laffer Associates’ report lightly; he rejected it out of hand. Not only did he reject it, he appeared so incensed that anyone could impugn the potential growth and profitability of energy producers, he took the time to write a detailed response.
The executive told the authors of the Laffer report that they were basically wrong about the outlook for the offshore-drilling industry both in the near term (6-12 months) and the long-term (1-5 years). He said that the outlook for offshore drilling had never been more certain. His confidence went beyond his managerial responsibilities when, in mid-1981, he stated that he was sad for us (Laffer Associates) and glad for Rowan shareholders even if the price of oil dropped below $24 per barrel.
By 1986, the price of oil had dropped below $10 per barrel, validating the conclusions of the Laffer study. Art Laffer and his associates were hardly “sad” at this turn of economic events.
When recently I came across my notes on this experience — especially at a time when oil prices are forecast to go beyond $100 per barrel in the next couple of years, according to one Wall Street analyst — I decided to take a look at how “glad” the shareholders of Rowan might have been in the years following the executive’s proclamation. In my opinion, Rowan Companies’ fundamental characteristics changed appreciably in the three years following the Laffer report as demonstrated by these statistics:
– In 1981, earnings per share were $2.22; by 1984 they were $0.08.
– In 1981, return on equity was 28.9 percent; by 1984 it was 0.7 percent.
– In 1981, the pretax margin was 46.7 percent; by 1984 it was -11.2 percent.
– In late 1981, the stock price hit $20; by 1984 it had fallen below $9.
As a follow up, I took a long-term perspective. I measured the performance of Rowan stock relative to the S&P 500 index from 1984 to the present. The S&P 500 increased 600 percent in this more-than 20-year period while Rowan stock increased only 200 percent. The passive S&P index tripled the performance of Rowan Companies.
In the final analysis, an unswerving commitment to a high-energy-price business strategy, demonstrated a major management flaw — the failure of one corporate executive to consider the risks associated with being wrong. In other words, as many professional investors have learned over the years, humility can be a very valuable asset.
– Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc. and principal of Victoria Capital Management, Inc.