Interpreting Management Red Flags

Insight into how I process unexpected developments

One of the critical features of due diligence and in particular maintenance due diligence is processing the changing situations related to the management team running companies you own. As news reports come out, you need to sort and filter between the words to understand *How* the management team thinks about certain issues whether that be capital allocation, expense management, growth, etc…

Over the last couple week I have had to process updates from a few companies that I have been following lately. My goal in this post is to share how I am thinking about changing dynamics in these companies. If I’m successful, you’ll have a greater insight into how I think about management teams, what is and what isn’t a red flag, and how sometimes a press release can express both positive and negative news for a company.

New Chairman at PharmChem

A press release from Chairman Tice Brown, at $PCHM was put out recently that announced he was stepping down from his position as Chairman of the Board.

Let us use this press release as an example for how you can sort through management *speak* as an investor.

First, note the yellow highlighted sections. Those are the *top line* announcement sections. Basically, Tice will be stepping down and will be replaced by former board member Tim Eriksen. This is neither a red flag or a green flag. Board changes can occur at any point and there isn’t anything negative about a particular chairman leaving their post.

If anything, this is an opportunity to study and understand a business because management changes can offer both risk and opportunity. If you own shares you need to understand the new manager. If you’re studying the business, perhaps this becomes a catalyst. (Positive or negative)

Now, consider that red section. The red section is possibly a red flag, depending on how you parse the reasoning behind it.

Alternative Headline: Chairman of PCHM reduces economic stake in business

This isn’t necessarily obvious, but when Tice contributes $PCHM shares into Tim’s fund, he will be reducing his economic stake in PharmChem by a large amount. Call it an 80-90% reduction (for the portion he contributes to the fund).

If you study Tim Eriksen’s fund letters, he owns a collection of cheap illiquid stocks. On a purely economic basis, Tice is trading shares of PCHM for a basket of cheap and illiquid stocks run by Tim’s fund. As an outside investor, you could take the bleak assessment that the controlling shareholder of PharmChem has decided that he is bearish enough on the stock to functionally sell a large portion of his stake in favor of another basket of businesses. This would be the *red flag* interpretation.

That’s not the only interpretation though. As I highlighted in green sections, you can see many areas where you can have a positive take on this change. Tice explicitly states he is:

• Going to continue being the 2nd largest shareholder

• Excited as he’s ever been

• There are personal reasons why he may want to step down

• Tim has an impressive track record which could make results at PharmChem even better than the past.

This would be a *green flag* interpretation of this announcement.

How I am thinking about PharmChem Moving Forward

My point of the above analysis is not to critique or favor Tice or Tim as a Chairman. I actually have been very impressed with both of them as managers in my time studying and following PharmChem and other companies. Instead, the goal was to provide an example of how you can break down a press release and pull information from it that may not necessarily be obvious on the surface.

Next though, I want to discuss my personal thoughts and takeaways in a more self-reflective manner.